Negative interest rates: Challenge or opportunity for Europe’s banks?
It has been five years since commercial banks, in
particular those in the euro zone, have faced a new challenge, that of
continuing to generate profit in an environment marked by negative interest
rates.
At the onset of the 2007-2008 global financial
crisis, several central banks implemented new “unconventional”
monetary policies. These consisted mainly of massive asset purchase programmes
(commonly known as Quantitative Easing, QE) and forward guidance on interest
rates. They aimed to lift the economies out of crisis by promoting better economic
growth while avoiding a low level of inflation (or even deflation). Since 2012,
six central banks in Europe (Bulgaria, Denmark, Hungary, Sweden, Switzerland
and the European Central Bank) and the Bank of Japan have gradually introduced
negative interest rates on bank deposits and reserves, in addition to the unconventional
measures already in force. For example, the ECB’s deposit facility rate now stands
at -0.40% (see Figure 1). Indeed, as indicated by Benoît Cœuré [1], the
implementation of negative rates aim to tax banks’ excess reserves to encourage
them to use these to boost the credit supply.
However, the implementation of negative rates has
raised at least two concerns about the potential effects on bank profitability
and risk-taking. First, the introduction of negative rates could hinder the
transmission of monetary policy if this reduces banks’ interest margins and
thus bank profitability. In addition, the lowering of credit rates for new
loans and the revaluation of outstanding loans (mainly at variable rates)
reduces banks’ net interest margin when the deposit rate cannot fall below the Zero
Lower Bound. Second, in response to the impact on margins, the banks could
either reduce the share of nonperforming loans on their balance sheets or look
for other assets that are more profitable than loans (“Search-for-yield”).
In a
recent article
[2], we used panel data from 2442 banks from the 28 member countries of the
European Union over the period 2011-2017 to analyse the effects of negative
rates on bank behaviour with respect to profitability and risk-taking.
Specifically, we asked ourselves three questions: (1) What is the impact of
negative rates on banks’ profitability? (2) Would negative rates encourage
banks to take more risks? (3) Would the pressure on net interest margins from
negative rates encourage banks to take more risk?
At the conclusion of our analysis, we highlight the
presence of a threshold effect when interest rates fall below the zero bar. As
can be seen in Figure 2, a 1% reduction in the central bank deposit rate
reduced banks’ net interest margins by 0.429% when rates are positive, and by
1.023% when they are negative. Thus, negative rates have a greater impact on
banks’ net interest margins than do positive rates. This result points to the
presence of a threshold effect at zero. In addition, in response to this
negative effect on margins (and in order to offset losses), the banks responded
by expanding their non-interest rate activities (account management fees,
commissions, etc.). As a result, in the short and medium term there was no indication
that the banks resorted to riskier positions. However, the issue of risk-taking
may eventually arise if negative rates persist for a long time and the banks
continue to suffer losses on net interest margins.
[1] Coeuré B.
(2016). Assessing the implication of negative interest rates.
Speech at the Yale Financial Crisis Forum in New Haven.
July 28, 2016.
[2] Boungou W. (2019). Negative Interest Rates, Bank Profitability and
Risk-taking. Sciences Po OFCE Working Paper no. 10/2019.