Given the limited scope for cutting deposit rates, low interest rates tend to depress net interest income. Thus, it will become increasingly difficult to maintain the cross-product subsidy whereby banks often exploit the loan-deposit spread to cover the cost of providing services to customers. Indeed it seems reasonable to expect that the zero fees policy will gradually fade into the background and that competition for deposits will shift in part to the business of providing transactional services. In any event, Spanish banks must adapt their business strategies to the new environment and must, in particular, take measures to continue to improve their operational efficiency. It is true to say that operational efficiency is, in general, already high in the Spanish industry in comparison with the rest of Europe, as Spanish banks on average have lower cost indicators than their euro area peers, but there are considerable differences from one institution to another and there is, therefore, room for improvement. It seems particularly appropriate to reflect on the need to adjust the commercial model of Spanish banks which is characterised, despite the industry consolidation, by a number of offices per capita which is much higher than the European average. In my view, both 6  BIS central bankers’ speeches  technological progress, which allows banks to increasingly interact with customers beyond physical points of sale, and the need to restore bank profitability on a sustainable basis, are sufficient arguments to support this reflection.
First, in an open economy setting, higher interest rates will attract even more capital inflows to Singapore, especially given our strong macroeconomic fundamentals and persistently low foreign interest rates. This could fuel further asset price inflation. Second, the hike in interest rates would have to be very aggressive for it to dampen demand for credit, and tame asset prices. This would mean a sharp appreciation in the exchange rate, which would impose significant collateral damage on the broader economy. Indeed, some regional countries with interest rate regimes are facing the dilemma between raising rates to curb credit booms and preventing the spillovers on capital inflows and their exchange rates. On balance, a switch to a regime of managing interest rates will be highly destabilising. There are potentially unpredictable costs associated with a shift in the monetary policy regime, quite apart from its limited impact on the other broader and more predominant sources of underlying price pressures in the economy. MAS’ assessment has been corroborated by Professor Ilian Mihov, Professor of Economics at INSEAD. His pioneering academic work has demonstrated that for an open economy like Singapore, a monetary policy response based on the exchange rate delivers superior economic welfare outcomes compared to an interest rate regime. In particular, the exchange rate is better able than the interest rate to reduce volatility in output and inflation.