Negative Interest Rate Policy (NIRP)

A Negative Interest Rate Policy (NIRP) is an unconventional monetary tool in which a central bank sets its policy (nominal) interest rate below zero. Under NIRP, depositors can be charged for holding funds at banks, rather than receiving interest, with the goal of discouraging hoarding and encouraging lending, investment, and spending.

Key takeaways

NIRP sets a central-bank target interest rate below 0%, reversing the usual positive return on deposits.
It is used as an extraordinary measure to combat very weak demand, deflationary pressures, or prolonged stagnation when conventional easing has been exhausted.
Implementations have occurred in parts of Europe and in Japan following the global financial crisis.
NIRP can stimulate borrowing and investment but carries risks such as cash hoarding, pressure on bank profits, and distortions in interbank markets.

How NIRP works

With negative rates, banks face charges on reserves or deposits held at the central bank and may in turn pay to hold customer deposits.
The intent is to lower borrowing costs, push banks to expand lending, and motivate businesses and households to spend or invest rather than keep money idle.
NIRP is typically considered when conventional policy has already reduced rates to (or near) zero and further stimulus is needed.

Economic rationale

During deflationary episodes or deep demand shortfalls, people and firms may hoard cash, reducing aggregate demand and deepening economic weakness.
Lowering rates below zero aims to make holding cash or bank deposits relatively costly, thereby reversing incentives to hoard and supporting consumption and investment.
It is effectively a last-resort monetary tool when other measures have not restored sufficient lending and spending.

Real-world examples

Swiss de facto negative rates in the early 1970s were used to counter currency appreciation driven by global investor flows.
Sweden in 2009–2010 and Denmark in 2012 used negative rates to address hot money flows and currency pressures.
The European Central Bank introduced negative rates in 2014 on certain bank deposits to ward off a deflationary spiral.
Officially set negative rates have also been observed in parts of Europe and in Japan after the 2008 financial crisis.

Risks and unintended consequences

Cash hoarding: If retail customers face penalties on deposits, they may withdraw cash and hold it outside the banking system, potentially triggering a cash run.
Bank profitability: Negative rates can compress banks’ net interest margins. Banks may absorb costs (hurting profits) or pass them on to depositors.
Interbank lending effects: Negative rates can reduce interbank lending activity and alter normal market functioning.
Distributional impacts: Applying negative rates to large institutional balances (pension funds, investment firms) while exempting small retail deposits is a common design choice to limit disruption, but it shifts the burden and can distort asset allocation decisions.

Design considerations

Central banks can target negative rates on reserves or on specific types of deposits rather than applying them universally.
Many banks avoid imposing negative rates on small household accounts to reduce the risk of cash withdrawals, instead applying charges to large corporate or institutional balances.
Policymakers weigh trade-offs between stimulating activity and maintaining financial stability, bank profitability, and public confidence.

Conclusion

NIRP is a powerful but unconventional policy used when conventional monetary tools have been exhausted and the threat of deflation or prolonged stagnation persists. It can lower borrowing costs and encourage spending, but it also carries risks—particularly to bank profitability and the potential for cash hoarding—that must be managed through careful design and targeted application.