In 2014, the ECB reduced its deposit rate to below zero, which means banks are paying the central bank to park their money. There is a current expectation this rate may be further extended into the negative when the ECB next meets in March as it seeks to stimulate bank lending. Some banks have passed on the negative rates to customers and this is causing an interesting reaction.
Negative interest rates are an incentive for depositors to withdraw their money from the bank, hold their savings in cash and rent a safe deposit box rather than pay the bank to deposit cash. With the euro having a relatively large denomination 500 euro note, it is possible to hoard a large amount of cash in a relatively small space outside of the bank.
This means the negative interest rate policy is being somewhat negated by the cash hoarding. And if interest rates move further negative, there is an even bigger incentive for people to hold cash. It also reduces the effectiveness of the monetary policy tool. Governments also lose track of where and how cash is being spent.
For some time police in various European countries have suspected the large denomination notes are being used by criminals. A Bank of Italy report said the notes were favoured by criminals because of the size/value ratio while a 2010 UK report said 90% of demand for the notes was from criminals.
All of this has led to a push by police and some officials to withdraw the 500 euro note from circulation reasoning it would make it harder for criminals to hide large amounts of cash. But doing this would also make it more difficult for regular, law-abiding citizens to stash their cash.
In the last week the ECB president has made a reference to the bank notes and their use by criminals and a review of high denomination bills is currently under way. Some see this as a prelude to a complete withdrawal of the notes as part of an underhand attempt by the ECB to make its monetary policy more effective.
Conspiracy theories of this sort may sound, well, like a conspiracy theory but a year ago former Bank of England official Charles Goodhart said, “If we were limited to low-denomination notes, at any rate because of the costs of stockpiling and all the rest we can drive interest rates a little bit further down.” If holding cash is impractical and banks charge interest for holding your money, then the incentive is to spend it, which is exactly what the ECB wants.
Switzerland has an even bigger issue as it has a 1000 Swiss franc note (approx. AUD$1450). A YieldReport article last year pointed out 1000 Swiss franc notes represent over 62% of the value of all Swiss currency on issue.