The effect of the Fed zero-lower bound announcement on bank profitability and diversification

Andrea Landi,Alex Sclip,Valeria Venturelli

doi:10.1080/1351847x.2020.1782961

Andrea Landi, Alex Sclip + Show 1 more

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https://doi.org/10.1080/1351847x.2020.1782961

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Abstract

In this paper, we investigate the impact of the Federal Reserve's decision to maintain the zero-lower bound for at least two years on bank profitability and strategies. Using a difference in difference setting, we find that banks with lower reliance on deposit funding are more sensitive to the policy event. Our evidence suggests that, compared to high deposit banks, the reduction in net worth of low deposit banks, induced them to change their strategies toward an increase in fee income to maintain the targeted level of performance. This increase is mainly explained by fiduciary and insurance-related revenues that entail a lower threat for financial stability.

Highlights

In response to the nancial crisis, the Federal Reserve (Fed) took decision to lower shortterm interest rates to zero and engaged in Large Scale Asset Purchase programmes (LSAP) of larger proportions1
A prolonged period of lower interest rates accompanied by a attening of the yield curve reduces revenues from loans and xed-income securities, compressing net interest margins of banks engaged in maturity transformation
We show that the Fed decision to maintain lower interest rates created a shock to bank performance, which resulted in a signicant shift in banks' strategies from interest income activities to noninterest income sources of revenues2

Summary

Introduction

In response to the nancial crisis, the Federal Reserve (Fed) took decision to lower shortterm interest rates to zero and engaged in Large Scale Asset Purchase programmes (LSAP) of larger proportions. A prolonged period of lower interest rates accompanied by a attening of the yield curve reduces revenues from loans and xed-income securities, compressing net interest margins of banks engaged in maturity transformation. This negative eect on the interest revenues may be partially oset through credit portfolio reallocation toward riskier loans, increase in lending volumes or an increase in noninterest income activities. We show that the Fed decision to maintain lower interest rates created a shock to bank performance, which resulted in a signicant shift in banks' strategies from interest income activities to noninterest income sources of revenues

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