Investors have been taught from very early to expect to be paid for taking on risk. When we give our funds to a bank, we expect to be compensated for lending them our money. We know that they use our funds to generate loans and make money from the spreads. This has been such a basic, fundamental premise of Money 101 that it has come as quite a shock to see the extent to which the European Central Bank (ECB) has been employing negative interest rates.

Europe has been fighting very low growth rates, deflation and high unemployment rates. Mario Draghi, in his capacity as president of the ECB has championed negative interest rates and it is included in his trademark playbook affectionately called “Draghinomics”.

First of all what are negative interest rates?

It occurs when instead of being paid for the use of your money, you are paying the other person for keeping your money! You are not earning anything and are in fact losing money on your investment.

Normally, any mention of negative interest rates elicits a nervous laugh and an immediate rejection of the idea. Why? Well, it seems ludicrous to pay the bank to keep your money, wouldn’t you be better off by keeping the funds under your mattress? Preferably with a loaded gun and a few Dobermans keeping watch? However, before reacting too strongly, let us take a look at the rationale for employing this very extreme move.

Negative rates are used by central banks to discourage other banks from placing their money with them. In times of uncertainty or low economic activity, it can be very tempting for banks to hoard cash and place with the central bank rather than creating loans to help to stimulate the economy.

That means the policy is not actually aimed at the retail investor, although that doesn’t mean they are not affected.

The ECB wants to stimulate growth and activity, and this is one of the monetary policy tools used to achieve that aim.

That said, the likely deposit rates would be zero for retail investors in the affected countries and not negative. So there is no need to get the guard dogs yet!

There is always a way to make money and believe it or not, banks can make money because of the direction of the negative interest rates. What do I mean by this? Mario Draghi cut rates from negative 0.3 per cent to negative 0.4 per cent. This would actually represent a gain for an institution holding an instrument at negative 0.3 per cent, for example, now that rates moved lower.

It is strange but true, the same principles of making money apply, that is, holding a security with a higher interest rate relative to the market has to be more valuable for the investor. This is particularly true if investors expect rates to go even lower, that is, more negative.

You may be tempted now to ask which countries would be crazy enough or brave enough to employ such a strategy.

Apart from the European Central Bank, Switzerland and Denmark have also employed these policies. In Switzerland’s case, it was done in the 1970s to discourage foreign investments. However, 2014 is when we saw the strongest resurgence of this phenomenon. Sweden had used this tool before and now Japan has joined the fray.

It is thought that it is a last resort measure, because if it is not successful, there really aren’t any other tools available in the central bank’s arsenal.

Janet Yellen, Chairman of the FED, was asked if the US would consider negative interest rates. She stated that they wouldn’t rule it out, but there weren’t any indications that it was necessary at this time.

Many of the pundits interviewed at the time were upset at the mere mention of any possibility of negative interest rates. The US has not had to deal with this kind of monetary policy and in fact are still expecting to raise rates possibly in the third quarter of the year.

Why would corporate investors still invest in bonds with a negative yield?

Sometimes, it is simply because they have to, for regulatory reasons. Foreign investors may have an incentive as well, if their local currency is devaluing at a rapid pace, as even with a negative interest rate, they will still make money. Foreign investors may be facing even bigger challenges in their local investment space than negative interest rates. They may therefore, choose to invest in a German bond, for example, for the safety (if not the return!).

The bottom line is that I could go on and on about negative interest rates, and it is certainly instructive to know about them and their investing implications; however, it is good to know that you have many investment options and you can earn attractive rates on US-denominated bonds when you do your due diligence and speak to an investment advisor.

Yanique Leiba-Ebanks is the AVP, Trading & Business Development at Sterling Asset Management. Sterling provides financial advice and instruments in US dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm. Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: info@sterlingasset.net.jm.