Although interest rates in the United States inched higher earlier this summer, around the world, rates remain low as countries try to spur economic growth. The strategy of keeping rates low in order to encourage growth is not new, but according to the CFA Institute, it may typify the future of the financial industry as continued low interest rates lead to low returns, anemic growth, and a climate of political and social instability.
In a previous blog post, I profile the CFA Institute’s Future of Finance report and it’s four prognoses of how the financial sector may evolve in the coming years: fintech disruption, parallel worlds, purposeful capitalism, and “lower for longer.” In the last scenario, the CFA predicts that perennially low interest rates and other factors—including excessive debt in both the public and private sector and aging populations—combine to prolong the period of weak growth that has followed the global financial crisis.
According to the CFA, low rates will bring about an abundance of global capital and low returns, which will prompt continued intervention by central banks even as those interventions begin to have diminishing impacts. Governments will be largely be unable to respond owing to crippling public debt.
Meanwhile, as average lifespans become longer, corporations and public entities alike will have a harder and harder time meeting their pension obligations, which will lead to pension crises and even pension poverty. This will simultaneously increase pension costs and damage corporate values, further complicating the process of economic recovery and growth.
Under such conditions, the world of finance will respond by deemphasizing innovation since the abundance of capital will mitigate the incentive to develop new products or practices. And while markets may become more efficient thanks to more advanced technology to assist in due diligence and price discovery, they will also become less liquid as capital migrates to fixed assets like real estate and infrastructure.
Financial service providers will also need to cope with a higher level of regulatory scrutiny. The CFA forecasts that lower returns will cause firms to increase their marketing efforts in order to attract new customers; consequently, this will attract a higher level of oversight from regulators and thus additional compliance costs, further shrinking firms’ margins.
To read the CFA’s full Future of Finance report, click here.