However, sometimes they have more money than their investment prospects can handle. Normally under those circumstances, they would buy treasuries from the federal reserve, which return the "risk-free rate". They always want to invest their money in things that return more than the risk-free rate, but sometimes they can't find enough stuff to invest in that they think will have a better return. In those cases, they're forced to buy treasuries.
Now, if the risk-free rate is negative, you might reasonably ask: Why doesn't the bank just keep cash? And the answer to that is that they're legally prevented from doing so. Banks have to maintain their capital reserves at the Fed, and the Fed pays them the "federal funds rate" on those reserves. So if they can't lend out the capital, they have to keep it with the Fed, where it earns whatever rate the Fed chooses to give them.
Some cursory research suggests this is not the case. The Federal Reserve website states: "Depository institutions must hold reserves in the form of vault cash or deposits with Federal Reserve Banks." [0]
[0] https://www.federalreserve.gov/monetarypolicy/reservereq.htm
How does what you said mesh with the notion that keeping cash might be riskier / more cumbersome than investing in the "risk-free" treasury bonds?
Banks are required by law to keep a portion of their assets on deposit in reserve. So if a bank has say, 1 billion in deposits, they might be required to maintain a balance with the Fed of 100 million.
What I think you're asking though is "why don't they just not keep the cash at the federal reserve". And the answer is that that's just not a thing you can do. Your bank maintains an account with the Fed - that's how it actually "stores" money. It can also physically store cash, but that comes with carrying costs (protecting it, etc.). Those carrying costs are one form of a negative interest rate.
At the end of the day, someone is storing the money somewhere. And the root-level money storer in the economy is the Fed. If the Fed wants to charge you 0.5%/year to store your money, what are your alternatives? You could keep physical cash. But then you have to protect it. You could invest in other assets, like stocks/bonds/mortgages, but those have risks. If you can't find any investments you like, and you don't want to physically store the cash, you don't really have any other choice.
No, they’re not. They must hold certain quantities of reserves with the Fed. But banks are free to hold the rest as cash in their vaults.
This is why many countries with negative rates still have zero deposit rates.
Also banks and certain investors are mandated to purchase debt with certain ratings - in the absence of positive-yielding appropriately rated bonds they have no choice but to accept the negative yield.
So for example let's say you bought a -0.1% yield, but newly issued bonds are now only offering a -0.5% yield you can now actually sell your bonds paying out -0.1% at a profit, since even if they paid you a 3.5% premium on the price you paid, it would still be more attractive than the rate on offer for new bonds.
There are no effective ways besides these bonds to hold tens or hundreds of millions of dollars as cash, even if you hire a warehouse, security, and store pallets of fiat (which has been attempted). You are paying a premium for principal safety.
You either make this choice voluntarily as an asset manager, or because you are required by regulation or other means to hold a percentage of your portfolio in this asset class.
https://wolfstreet.com/2017/01/28/europe-limits-on-cash-tran...
But in the EU, the deposit rate set by the ECB is -0.40%. So that would explain why EU banks would be willing to buy negative yielding bonds instead to hold in reserve, as long as the yields on those are less negative.
But then the yield on German bunds is actually even lower, hitting -0.60% recently, so it's not just that.
https://portfoliocharts.com/2019/05/27/high-profits-at-low-r...
I have a hard time seeing interest rates continuing to drop, however. (On the other hand, I never thought I'd see them this low. But they can't keep going lower forever... can they?)
If you have $1000 today and can either spend it now or put it in the bank and withdraw $999 a year from now, what would you do? I suspect some would spend it now.
But what if that number goes down to $990 or $975? More and more people will be willing to spend it now instead of savings therefore "growing" the economy now.
First, since you don't have to make payments, you can't default.
If you can't default, why bother with qualification?
If you don't have to qualify, is there an upper limit to how much you can/should borrow?
If there's no upper limit and you never have to pay, it doesn't matter whether the seller charges $100k or $1M or $10M.. it demonstrates that the entire system is entirely made up.
Negative interest rates make sense if you consider them as a lender trading current cash-on-hand for future cash flow. That is, the bank has $200k today, but it would rather see that broken up into payments over 10 years, even if it has to pay you to do it.
When viewed through this lens, it becomes clear that the factor driving this is likely that the bank is being disincentivised from storing the cash directly.
In fact, I would be surprised if you could get away with no payments (a balloon payment loan, as it were). I would be rather shocked if they were offering such loans.
Absent data that they are actually offering such loans (balloon and/or untethered to the price of the property), I find your conclusions unwarranted.
"In Denmark, the ultra-low interest rate environment has in turn caused home prices to increase as borrowers could afford pricier homes."
Ref: https://www.msn.com/en-us/finance/markets/a-danish-bank-is-o...
This applies whether you are a person with a wallet/mattress, or a bank with a high security vault.
That happens regardless of the interest rate and affects both cash and bond/treasuries.
Institutions don't have that luxury - the government doesn't insure large amounts of cash. If they keep it in a bank and the bank goes under, they lose their money. So they keep their money in national governments, which are far safer than banks.
Due to the low interest rates German insurance companies are already considering to store cash in their own vaults instead of buying bonds: https://translate.google.com/translate?hl=&sl=de&tl=en&u=htt...
Slightly negative interest rates work because physically storing cash is going to be more expensive than buying bonds (especially if you factor in costs for security, insurance, etc.). But if interest rates decreases further it's soon going to be cheaper to store cash, which is going to create a lower bound for the interest rate (assuming the government doesn't prohibit storing large amounts of cash).
So your guess is that insurance companies, companies for which their entire business model revolves around risk management, are not taking into account something as mundane as risk of theft?
That's a... curious line of reasoning.
Bonds are claims on sovereigns with a printing press.
What has a lower chance of default?
Why is there even a market for a bond with negative interest rates at all, since compared to a $X bond with negative interest, $X in currency seemingly carries less risk, more liquidity, and a higher rate of return?