Since 2012, central banks all over the world have progressively pressed rates of interest below zero. Once an intellectual curiosity, today rates of interest are negative in countries comprising 25% of world GDP and most $17 trillion price of securities provide a negative yield (BIS 2019). Furthermore, going negative is more and more considered like a serious policy option. Because of the lengthy-term loss of nominal rates of interest, the opportunity to lower real rates of interest by cutting policy rates below zero might help in answering economic downturns (Rogoff 2017). As governments aim to combat the current recession introduced on by COVID-19, discussions around the potency of negative rates remain high in policy agenda (Tenreyro 2021). However, it’s unclear exactly how negative rates transmit to real business activities with the banking system. A specific problem is that lengthy spells of sub-zero rates could increase the chance of financial disruptions or discourage banks from performing financial intermediation (Eggertsson et al. 2019).
Figure 1: Deposit facility rate, Eonia rate, and rates on loans and overnight deposits for households and non-financial corporations (weighted average) within the euro area.
A line chart showing four rates: interbank, policy, deposits, and loan rates.
Source: ECB (2020).
Calculating the outcome of negative rates on bank lending
Inside a recent paper (Grandi and Guille 2018), we empirically read the transmission of negative rates in France and also the euro area using bank and private bank-firm-level data. Consistent with Heider, Saidi, and Schepens (2019), we exploit the imperfect transmission of negative rates to deposits to recognize the outcome of negative rates on banks’ activities. While negative policy rates substantially decreased short-term rates and lending rates, transmission to retail deposit rates was limited (see figure 1). The existence of cash and anxiety about deposit withdrawals likely made European banks unwilling to charge negative nominal rates on deposits, especially on individuals held by households and small companies (ECB 2020). Consequently, the funding costs of deposit-dependent banks face a tough floor at zero. This friction, consequently, creates variation in how negative rates affect different banks: following a rate decline in negative territory, banks with large shares of deposits should notice a compression in internet interest margins (i.e., multiplication between your rate earned on loans which compensated on deposits) in accordance with banks which are mostly funded on wholesale markets.
In principle, negative rates might have different outcomes on lending. Around the one hands, the squeeze in margins could erode equity and, consequently, limit banks’ capability to supply loans (Brunnermeier and Koby 2018 Eggertsson et al. 2019). However, banks may make an effort to preserve their profitability by growing lending, especially to riskier borrowers, and by purchasing greater-yielding assets (Bottero et al. 2019 Bubeck, Maddaloni, and Peydró 2020). Our technique is to check both ideas utilizing a variations-in-variations setup to check the evolution in lending by banks with everywhere shares of deposits (i.e., treated and control groups, correspondingly) pre and post the development of negative rates through the European Central Bank (ECB).
Negative minute rates are connected with increased lending and high risk
Using credit registry data for France, we reveal that negative rates transmit to bank lending via deposits. First, banks most dependent on deposits extended more loans relatively with other banks following the ECB decreased the insurance policy rate below zero in June 2014. The result is economically sizable: following the policy rate entered zero, a 1-standard-deviation rise in banks’ deposits-to-assets ratio is connected having a 13% rise in loans to non-financial corporations and households. Second, the rise in lending is most powerful for banks that depend on bank account deposits by households, confirming the significance of retail deposits for that transmission of negative rates. Third, negative minute rates are connected with search-for-yield, as treated banks improve their asset share of corporate loans and debt securities by greater than control banks following the development of the insurance policy.
Figure 2: Improvement in lending between treated and control banks with time. The red line matches the entire year once the ECB first decreased the deposit facility rate below zero.
Dotted vertical dotted bars showing improvement in lending between treated and control banks with time. The red line matches the entire year once the ECB first decreased the deposit facility rate below zero.
Do these results hold outdoors France? We run similar tests on the sample covering all euro area countries and reveal that our results have broader exterior validity. High deposits banks within the euro area expand credit by many occupy more risk regarding other banks within the years following the development of negative rates. In conjuction with the timing of the implementation, figure 2 implies that lending by treated banks elevated substantially after 2014 in accordance with control banks. Similarly, figure 3 reveals an optimistic relationship between banks’ deposits ratio and also the alternation in lending between your pre/publish negative rates period, indicating that banks with bigger shares of deposits experienced greater lending growth since the development of negative rates.
Figure 3: Alternation in lending between pre/publish negative rates across 100 percentiles of banks’ deposits ratios (weighted by loans in every percentile).
A bubble chart: blue circles more than a red line showing the modification in lending between pre/publish negative rates across 100 percentiles of banks’ deposits ratios (weighted by loans in every percentile).
Our findings claim that negative minute rates are good at stimulating the economy when nominal rates of interest hit the zero lower bound, via a rise in bank lending. This effect is more powerful for banks more dependent on retail deposits and comes in the cost of and the higher chances taking. This evidence hence cautions policy makers the additional accommodation supplied by venturing into negative territory ought to be considered from the potential build-from risk within the banking system go to concerns for financial stability. Additionally, the discovering that negative rates possess a more powerful effect on high deposits banks has institutional and distributional implications. First, due to variations within the structure of deposit markets across countries, negative rates may transmit heterogeneously across people from the euro area. Second, banks more dependent on deposits are more inclined to give loan to medium and small-size enterprises, which are overwhelmingly determined by banks for exterior finance. By encouraging high deposits banks to lend, negative rates may therefore assist in easing credit conditions, particularly which are more financially restricted borrowers.
BIS (2019) “Quarterly Review”. Worldwide banking and financial market developments, September 2019.”
Bottero, M. et al. (2019) “Negative Financial Policy Rates and Portfolio Rebalancing: Evidence from Credit Register Data,” IMF Working Paper (44).
Brunnermeier, M. and Koby, Y. (2018) “The Reversal Rate Of Interest,” NBER Working Paper. Cambridge, MA (25406).
Bubeck, J., Maddaloni, A. and Peydró, J.-L. (2020) “Negative Financial Policy Rates and Systemic Banks’ Risk-Taking: Evidence in the Euro Area Securities Register,” Journal of cash, Credit and Banking, 52 (S1), pp. 197-231.
ECB (2020) “Financial Integration and Structure within the Euro Area.”
Eggertsson, G. et al. (2019) “Negative Nominal Rates Of Interest and also the Bank Lending Funnel,” NBER Papers. Cambridge, MA (25416).
Grandi, P. and Guille, M. (2018) “The Upside Lower: Banks, Deposits and Negative Rates”, Working Paper.
Heider, F., Saidi, F. and Schepens, G. (2019) “Life Below Zero: Bank Lending under Negative Policy Rates,” Overview of Financial Studies, 32(10), pp. 3728-3761.
Rogoff, K. (2017) “Dealing with Financial Paralysis in the Zero Bound,” Journal of monetary Perspectives. American Economic Association, 31(3), pp. 47-66.
Tenreyro, S. (2021) “Let’s Discuss Negative Rates Of Interest”, Speech given in the UWE Bristol web seminar, Bank of England.