LONDON Fears that the negative interest rates employed by a growing band of central banks could be doing irreparable damage to the financial sector are spurring a search for even more radical alternatives.
A rout in bank debt and equity markets over recent weeks has led many investors to speculate that negative rates, effectively a tax on banks designed to encourage them to lend, are now part of the problem rather than the solution.
Alternatives such as complex tiered interest rates, purchases of bank debt and shares or even a tax on hard cash are all being touted by radical thinkers.
The Bank of Japan has just become the latest central bank to join the sub-zero club, Sweden took its rates even deeper into negative territory on Thursday and markets are betting the European Central Bank will shave another 10 or 20 basis points of its -0.3 percent deposit rate next month.
With some economists talking about the potential for another global recession, even the U.S. Federal Reserve, which in December raised rates for the first time in a decade, is analyzing the prospect of a turn negative.
"It is not a coincidence that strains in the banking sector follow the Bank of Japan's decision to cut interest rates into negative territory," said Richard McGuire, head of interest rate strategy at Rabobank. "You are cutting off your nose to spite your face."
This week's selloff has brought long-acknowledged drawbacks of negative rates sharply into focus. European bank shares have slumped to new multi-year lows and the cost of insuring subordinated bank debt is now up more than 80 percent this year ITEFS5Y=.
Sub-zero rates effectively charge banks that park cash at the central bank, but those costs are difficult to pass on because customers can pull their money out of their accounts and leave the banks with big holes in their balance sheets.
The central banks can soften these blows by limiting what their negative rates are applied to. The Bank of Japan is using different tiers of rates, for example, and the ECB has discussed similar measures.
Frankfurt is unlikely to implement that kind of approach yet though. Such tinkering can dull the intended impact, which is to get the economy moving, but with the banking sector fretting over negative rates, the search is on for alternatives.
ECB policymakers have in the past discussed including bank and corporate debt or riskier asset-backed securities (ABS) in their 1.5 trillion euro ($1.7 trillion) bond-buying scheme and free-thinking chief economist Peter Praet has even mentioned shares or gold as theoretical options.
Most of those steps are tricky, because the ECB would need to do it across 19 euro zone countries, but not impossible. The ideas of buying government bonds and negative rates were spoken of as virtually dark arts until a year or two ago.
"There has been nothing ruled out on purpose," Pictet Wealth Management's European economist Frederik Ducrozet said.
There are precedents, too. During the Asian crisis of the late 1990s, Hong Kong's central bank bought up roughly 20 percent of locally-listed blue-chip shares and the Bank of Japan has been doing it recently by buying up equity Exchange Traded Funds.
Other ideas floated by economists and academics for the ECB include a loan scheme that effectively pays banks to take cash, or intervention in inflation-linked derivatives which would prop up market forecasts for consumer price growth.
If deeper negative rates mean banks are charged ever larger penalties on deposits, there is the assumption that at some point they will transfer the money into physical cash and stuff it underground in vaults with armed guards.
Even at zero interest and after paying the guards, it would still give them a better return. Some academics last year discussed taxing or getting rid of physical cash, but that would only exacerbate the strain on banks.
Yet despite the recent market unease about the effects on the financial system of increasingly negative interest rates, for now at least they seem to be the central bankers' weapon of choice.
JP Morgan said this week the ECB could cut rates to -0.7 percent by the middle of the year and theoretically at least go as low as -4.5 percent over time.
And if that doesn't make heads spin, the U.S. Federal Reserve, which has only just raised rates, could slash them back to -1.3 percent, the Bank of England to -2.5 percent and Japan to -3.45 percent, JPMorgan added.
"It is the analogy of the toolbox," said the head of pan-European fixed income at Aberdeen Asset Management, Neil Murray.
"If you really need a drill, but you've never heard of a drill and you've only got a hammer, then you will probably just keep on hammering."
(Reporting by John Geddie and Marc Jones; Additional reporting by Dhara Ranasinghe; Editing by Ruth Pitchford)