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Mar. 10, 2015 - Updated 04:16 UTC

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Impact of Negative Interest Rate

Yuko Fukushima

Mar. 18, 2016

Japan's central bank introduced a negative interest rate last month, and the unprecedented move is affecting the economy in both positive and negative ways.

The Bank of Japan continues to pump huge amounts of money into the markets. But after 3 years of monetary easing, the economy is still struggling to shake off deflation. So the bank tried something new: dropping its key interest rate below zero.

One bright spot is the housing market. People who sell houses are busy telling prospective customers this is the time to buy.

Banks have cut their home mortgage rates. Some mega-lenders have dropped their rates for a 10-year loan below 1 percent. The real estate industry is gearing up to profit.

"We expect more people will be looking to buy new homes. We have to thoroughly explain the benefits of the negative interest rate to our customers," said Takuma Mitsui, who is with homebuilding company Sekisui House.

But what about people who are not in the market for a new home? There's a lot of uncertainty on the streets.

A negative rate works as follows: The Bank of Japan is the bankers' bank. Commercial banks park any money they're not using in the central bank. Before February 16th, banks were paid interest of 0.1% on all their deposits. But starting last month, the central bank cut its key overnight rate to minus 0.1%. This applies to some but not all deposits.

This means banks don't earn interest. Instead, they have to pay a fee for their deposits. And that is the real point of negative rates. The Bank of Japan is putting the squeeze on financial institutions to withdraw their deposits. It's hoping the commercial banks will lend this money to companies.

Seibu Shinkin Bank is a small, regional lender that has taken the hint.

It used to have about $800 million deposited at the Bank of Japan. After the negative rate was announced, that amount was cut by a third.

The bank also sent its loan officers out to find more clients. One recently visited a startup company that provides rehabilitation services geared toward Japan's growing population of elderly.

"Could you tell me about your capital needs and what you think about loan rates?" he asked the startup firms president and CEO, Yasuhiro Hayami.

"We see the lower interest rate environment as an opportunity to expand our business," Hayami replied. "For venture firms like us, interest rates are no small matter."

The bank rep thinks if he offered a lower rate for a loan, he'd win a new customer -- perhaps many more. But a lower interest rate also means less profit for Seibu Shinkin.

The bank's executives met to discuss future loan rates, and decided to cut its interest rate by half.

"In the short run, our earnings will decline. But at the same time, our clients stand to gain. I believe this will create a virtuous cycle of stable demand for capital," said Kanji Ochiai, the bank's president.

Bank lending isn't the only volatile area of the economy. The BOJ rate policy has lobbed a grenade in the long-term bond market.

Last month, the yield on key Japanese 10-year government bonds dipped below zero for the first time ever. That's affecting companies in different ways.

With interest payments at a record low, West Japan Railway Company decided it was the ideal time to upgrade its safety equipment. It raised $90 million by issuing a 40-year bond. Other firms are thinking of following suit.

But not everyone is benefiting from lower rates. Nippon Life Insurance has been a major buyer of Japanese government bonds. That's because they're considered a safe asset. But now, with the yield going negative, it's seeking advice from overseas brokerages.

Negative rates are reshaping the investment world. And just like the people on the street, fund managers are struggling to come to grips with the changes.

"We are concerned we won't be able to fulfill our duties as a life insurer," said Kazuo Sato, with Nippon Life Insurance. "This new age will test our investment skills, our ability to make quick calls and purchase assets at undervalued prices."

Investors are still adjusting to the new era. On Friday, the yield on the 10-year Japanese Government bond fell to another record low -0.135%.

Experts are divided over where the BOJ's negative interest rate will take Japan in the months -- and perhaps years -- ahead.

Takashi Hiroki, chief strategist at Monex, is one economist who thinks the negative rate policy is the right move for the economy. He says it will encourage companies to start spending.

"Up until now, the general view was that the central bank has not been able to stimulate the economy through its monetary easing policies because companies don't have any need for more capital," he said. "But if borrowing money becomes this cheap, I think more companies will think about requesting loans and issuing bonds to expand their businesses."

Other economists say the BOJ's new policy will do more harm than good. Norihiro Fujito, senior investment strategist at Mitsubishi UFJ Morgan Stanley, cites the situation in Europe. He says banks there were hit hard after the European Central Bank adopted negative rates in 2014.

"Last year, Germany's leading bank, Deutsche Bank, slipped into the red for the first time since the financial crisis in 2008," he said.

"In Japan, bank and insurance stocks tumbled shortly after the Bank of Japan announced its negative interest rate policy on January 29th. This implies these sectors will have difficulty making money, just like their European counterparts have. This is fueling the concerns that profits at finance companies will shrink."

Fujito's main concern is a further decline in the price of bank stocks. He believes a market slump will put the brakes on consumer spending -- even among people who don't own shares.

"Rich people spend money on things like condominiums, expensive cars and other luxury items. If they switch to lower-grade products, this may have a negative impact on corporate earnings," he said.

"That will prevent companies from raising wages and impact workers who don't own stocks. So I'm afraid the BOJ's move will dampen consumer sentiment and cool the whole economy."

Even if the negative rate has a positive result, many experts agree central bank policy alone isn't enough to turn the economy around.

They're calling for deregulation and other reforms to get companies spending. That's a job for the government, not the BOJ.