You’ve probably heard by now the whispers of possible negative interest rates. In fact, lately it’s been much more than a whisper but front page news as Fed Chair Janet Yellen addressed the possibility before a Senate during yesterday’s testimony. What is a negative interest rate and how does it work? Or does it work at all?

The concept of a negative interest rate is a bit counterintuitive. Banks charge interest on money loaned. The interest rates charged will depend upon the type of collateral or venture being financed and the current cost of funds to the bank. The Fed attempts to control the cost of funds by adjusting the Federal Funds rate, the rate set by the Fed that banks can charge one another for short term loans. The target Fed Funds rate is 2.00%. Last December, the Fed boosted the rate from 0.25% to 0.50% and the prospect of increasing this rate sometime this year is beginning to look less likely.

A negative interest rate on the other hand is a potential tool the Fed can use to stimulate lending by banks. The Fed can charge a fee to banks on the amount of reserves held at the central banks. The theory is it is better to make loans to businesses and individuals and charge interest than it is to pay the fee for not making loans and sitting on the cash instead.

While our economy is gradually making progress and jobs are being created the recent glut of oil and a potential global slowdown is having an impact on stocks, most especially bank stocks. The Fed has never implemented a negative interest rate policy and just recently queried some banks to ask how they might react to such a new policy. A low rate environment is considered to be the primary tool the Fed has to help an economy recover but rates have been so low for so long some are wondering if this tool really has an impact. Which might mean the Fed will introduce this brand new tool of a negative rate.