Deposits up to a specific quota are remunerated at the key policy rate, which is Norges Bank’s sight deposit rate. Deposits that exceed the quota are remunerated at a rate below the key policy rate, referred to as the reserve rate. 1 Banks that borrow overnight from Norges Bank pay the overnight lending (D-loan) rate. As shown in the chart, the reserve rate and the overnight lending rate are set respectively at 1 percentage point below and 1 percentage point above the key policy rate. 2 Interbank transactions take place throughout the day. The transactions are settled via the banks’ accounts with the central bank. Banks with deposits above the quota at the end of the day normally lend reserves overnight to banks with a negative balance in Norges Bank or to banks that have deposits below the quota. Chart: Norges Bank interest rates and market rate The interest rate on these transactions, called the overnight interbank rate (NOWA in Norway), is normally very close to the key policy rate. The interest rate corridor around the key policy rate is intended to promote reserve trading between banks and not between banks and the central bank. This contributes to an active interbank market and an efficient money market. In order to keep the overnight interbank rate close to the key policy rate, Norges Bank aims to keep banks’ total reserves below the sum of the quotas that can be remunerated at the key policy rate.
But even though the zero lower bound is not absolute, the effect of further cuts will diminish as rates approach or fall below zero. The most important limitation on how far down it makes sense to go is related to the existence of an alternative to bank deposits, i.e. cash. Negative bank deposit rates can always be avoided by holding cash instead. The disadvantage is that cash is more expensive to manage than electronic deposit money. Transport, storage and security all involve costs. For a bank participating in the settlement system, where large amounts are reinvested at frequent intervals across accounts and across banks, the costs involved in switching to cash will be considerable. Central bank deposit rates can therefore be below zero. How far below, is an open question. For many retail customers, exchanging bank deposits for cash will be fairly inexpensive. A safe deposit box can be rented for less than € a year. If bank customers choose to withdraw their deposits and hold cash, banks will lose an important part of their funding. This is probably an important reason why banks in countries with negative policy rates are reluctant to set negative deposit rates, particularly for households. If banks hold back on deposit rates, lending rates can only fall to a limited extent before banks’ earnings are reduced. A lower policy rate will probably have a less-than-normal effect on lending rates, weakening the impact of monetary policy via the demand channel.