Heterogeneity in Net-Interest Income Exposure to Interest Rate Risk and Non-Interest Expense Adjustment

Abstract

In this paper I document two new facts. First, bank net-interest margins (NIM) are insensitive to the short rate on average but this masks substantial heterogeneity in the cross section. I find cross sectional variation ranging from a -30bp to +40bp change in one quarter NIM after a 100bp change in rates, which compounds over the following four quarters. I find that this cross sectional heterogeneity is driven by differences in bank business models. Second, bank NIM sensitivity to rate changes is muted by offsets in non-interest expenses, reducing ROA sensitivity by approximately 30% on average. The positive relationship between net-interest income and non-interest expenses is somewhat consistent with investment sensitivity to profitability, but is also consistent with the management of expenses in order to prop up earnings to meet executive performance targets. These findings have implications for understanding how the net-worth channel of monetary policy operates in the cross section and can help inform policy related to the existence of a ``reversal rate''.