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Negative interest rates – the legal context

Update Banking & Finance 12/2017 - Finance

Negative interest rates have played an increasingly significant role in banking practice ever since the European Central Bank (ECB) began imposing negative rates on deposits from commercial banks in 2014. In more and more cases, the ECB’s interest rate policy is causing banks to pass on their interest charges to business and private customers. Discussion of the associated legal issues has ensued, as one would expect when market developments take an unexpected turn. Any assessment of the legal situation may have significant economic consequences, meaning that statements made in the literature may well be driven by special interests. A few basic principles are outlined below. Full presentation of the details is not possible within the scope of this short article, but it should be emphasized that much of the content below is subject to dispute.

Negative interest rates – interest in the legal sense?

Leaving aside some detailed distinctions, interest is generally defined as the fee charged for the temporary use of capital for a given period of time.

At first sight, this definition does not seem to cover the extra costs charged by banks in the form of a negative interest rate, with business and private customers having to pay an additional fee for depositing their capital. The economic and legal justification for this behaviour arises from the classification of the deposit agreement as “irregular safekeeping”. The provider of the capital pays a fee to the depository in return for safekeeping of the money deposited. When the depository is able to generate good returns by investing the capital, the depository shares these returns with the provider of the capital, minus the safekeeping fee. If the depository fails to generate any income, the fee is deducted from the capital.

This can be regarded as the prevailing point of view with regard to demand deposits in current accounts. Deposits of this kind involve an irregular safekeeping contract pursuant to section 700(1) clause 1 of the German Civil Code (BGB). Although this legal provision makes reference to the law on loans, it does not generally provide for an obligation to pay interest. As such, negative interest rates on current accounts are not interest payments, but rather a safekeeping fee paid on an ongoing basis.

A different view is sometimes taken when considering time deposits, based on the belief that this type of transaction involves the customer making a loan to the bank. However, the law does not expressly provide for a positive interest rate. A crucial feature in the definition of interest is the fact that additional costs are payable if capital is provided to a bank. Whether these costs are incurred by the investor or the bank is immaterial when it comes to classifying such costs as interest.

Can a negative interest rate be legally charged?

Agreements on negative interest rates cannot be generally regarded as invalid, despite the fact that the customer is clearly subject to a charge.

Negative interest rates cannot be charged unless there is a contractual basis for doing so.

There are no legal obstacles to making an individual contractual agreement on charging a negative interest rate, as per the principle of freedom of contract. An interest rate adjustment clause or variable rate clause may also qualify as an individual contractual clause. In the case of more recent contracts, entered into against the backdrop of the ECB’s current financial policy, the parties will have been aware of negative interest rates when concluding the contract. If the contract was entered into prior to the current period of low interest rates, or if no corresponding clause was included, then negative interest rates are not covered by the agreement on interest.

Agreement on negative interest rates can also be brought about through valid incorporation of standard terms and conditions.

The key statutory provision, section 488(1) clause 2 of the BGB, does not require a positive rate of interest to be paid on savings deposits. A negative interest rate clause in terms and conditions represents a primary price agreement with regard to the above categorisations and is not subject to a test of reasonableness. The argument that such a clause is “surprising”, pursuant to section 305c(1) of the BGB, is unlikely to be accepted either, given recent developments in financial policy. A challenge based on lack of clarity pursuant to section 307(1) clause 2 of the BGB is the only feasible option. It is important with respect to all of the above that the procedural rules provided for in the standard terms and conditions generally used by German banks are followed. If no such clause is effectively incorporated into terms and conditions, there is no contractual basis for charging a fee.

Incorporation of negative interest rates into the contract by way of termination of the contract with the option of entering into a modified contract could be a solution for older contracts that do not contain an agreement on negative interest rates, at least until a federal court judgment is available.

Negative interest rates and the common good purpose of German savings banks

There is particular uncertainty regarding the extent to which negative interest rates are compatible with the public mission of German savings banks (Sparkassen) under regional state laws. Savings banks are tasked with supplying money and credit to the population and promoting savings/pension provision. Negative interest rates would appear to run contrary to this objective.

Savers could resort to alternative forms of investment as a result of additional costs for depositing money at a bank. However, this incentive is precisely the reason why savings banks are not in breach of their defined mission when introducing negative interest rates. The idea of private provision – provision that can also be implemented through alternative investments – lies at the heart of promoting a culture of saving.

A general ban on negative interest rates for savings banks would put them at a significant competitive disadvantage in the current market environment. An uncompetitive savings bank would also be unable to fulfil its mission of supplying the population with money and credit.

Summary

There are no legal obstacles to individual contractual agreements on negative interest rates – a situation which should also apply to savings banks. Effective agreement in general terms and conditions is likely to be permissible, but clarification by the highest court is still outstanding.


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Authors

Portrait ofHerbert Wiehe
Dr. Herbert Wiehe
Partner
Cologne