The Channels of Banks’ Response to Negative Interest Rates

Abstract

Facing a potential zero lower bound on retail deposit interest rates, how do banks pass on the fall in net interest income due to negative interest rates? This paper aims to investigate the different channels of banks’ responses to negative interest rates using a detailed breakdown of the profit and loss account of 3645 banks in 59 countries from 2011 to 2018. We find that the decrease in interest income due to negative interest rates has been mitigated only partially by an increase in non-interest income. We show that banks responded to that shock by reducing the interest paid on non-customer deposit liabilities and their personnel expenses. We also show that banks’ responses are not instantaneous and that banks adjust their response as negative interest rates persist over time such that how long negative interest rates are implemented matters.