Negative Interest Rates Research Articles

The impact of economic policy uncertainty on banks' non-interest income activities

This paper investigates how banks adjust their business model amid rising global economic uncertainty. Specifically, we analyze the effect of economic policy uncertainty (EPU) on banks' non-interest income activities, using a large panel dataset of 3913 banks operating in 9 countries over the period 2009–2018. We find no statistically significant effect of EPU on banks’ net non-interest income (NNII). Further analysis shows that the lack of impact on NNII is due to a reduction in gross non-interest income which was offset by a decrease in gross non-interest expenses. Our results also suggest that the likelihood of banks to diversify income amid high EPU is conditional on the negative interest rate environment.

Effects of a negative interest rate policy in bank profitability and risk taking: Evidence from European banks

This paper analyses the effect of a negative interest rate policy (NIRP) on profitability and risk taking in the European banking sector and whether this effect is differentiated according to the bank business model. Using a dataset of 2596 banks from 29 European countries over the period 2011–2019 and applying a static modelling approach, we conclude that the implementation of NIRPs lowers the net interest margin and the return on assets of a representative bank by 14.5 basis points and 18.5 basis points, respectively. We also conclude that a decrease in the short-term interest rate lowers the net interest margin when interest rates are already negative. In an environment of negative interest rates, we do not find that European banks take on more risk and conclude that the effects of the implementation of NIRPs influence banks’ profitability and risk taking differently, depending on the business model adopted.

A tiering rule to balance the impact of negative policy rates on banks

Negative interest rate policy makes excess liquidity costly to hold for banks and this may weaken the bank-based transmission of monetary policy. We design a rule-based tiering system for excess reserve remuneration that reduces the burden of negative rates on banks while ensuring that the central bank keeps control of interbank interest rates. Using euro-area data, we show that under the proposed tiering system, the aggregate cost of holding excess liquidity when the COVID-19 monetary stimulus fully unfolds would be more than 36% lower than that under the ECB’s current system.

Expansionary yet different: Credit supply and real effects of negative interest rate policy

We show that negative interest rate policy (NIRP) has expansionary effects on credit supply through a portfolio rebalancing channel. By shifting down and flattening the yield curve, NIRP differs from rate cuts just above the zero-lower-bound and has effects similar to QE. For identification, we exploit ECB’s NIRP and the Italian credit register and, for external validity, European and U.S. datasets. NIRP affects more banks with higher ex-ante liquid assets, including net interbank positions. More exposed banks reduce liquid assets, expand credit supply, especially to financially-constrained firms, and cut loan rates, inducing firms to increase investment and the wage bill.

Preference heterogeneity and optimal monetary policy

We study optimal policy design in a monetary model with heterogeneous preferences. In the model, financial markets are incomplete and households are heterogeneous with respect to their current consumption preferences and discount factors. The government controls the supply of money (liquid) and nominal bonds (illiquid), and households make optimal portfolio choices. We uncover that the two types of preference heterogeneity have distinct distributional consequences and different implications for the optimal monetary policy. While the heterogeneity in current consumption preferences pushes the economy towards a zero lower bound (ZLB) associated with nominal interest rates, the heterogeneity in discount factors moves the economy away from the ZLB. We characterize the optimal policy design and quantify the welfare losses associated with a binding ZLB - and thus also the potential welfare benefits of being able to implement negative interest rates.

Managing the Risks of Negative Interest Rates

The acceleration in the issuance of government debt since the global financial crisis has led central bankers to engineer interest rates that are historically low in nominal terms and consistently lower than inflation rates. Although the ostensible aim of this policy is to stimulate economic growth, maintaining negative real rates also goes a long way so that government debt is manageable and will decline in the long run, relative to the size of the economy. Financial institutions hold the great majority of government debt, and their books of retail and corporate loans are expanding briskly at a time when ultra-low interest rates make borrowing especially attractive. Rates paid on deposits are low, in advanced economies, even negative in the euro zone in nominal terms. That helps to offset the reduction in income that banks earn on their lending. Even so, the extreme and unique conditions resulting from persistent negative real interest rates mean that banks must take particular care to manage their interest-rate risk in the context of other risk types and the banks’ profit-and-loss analysis.

Modeling Euribor Rates Volatility: Application of the GARCH Model

Euribor (Euro Interbank Offered Rate) is considered to be the most important base rate for all types of financial products like interest rate swaps, interest rate futures, saving accounts and mortgages. Euribor rates turned negative for the first time in January 2015 and have been negative ever since. In recent years, several European central banks have imposed negative interest rates on commercial banks, which is the only way to stimulate their nations' economies. Under these circumstances, the purpose of this study is to estimate the optimal equilibrium of the negative rates which are still increasing constantly. This fact raises doubts about the financial stability in many countries and the effect of monetary policy in stimulating economic growth in European countries. This study has analyzed the volatility of the Euribor rates related to the daily time series 2015-2021. Advanced volatility econometric methods are applied to GARCH models and volatility forecasting in the long-run equilibrium. The optimal model for the weekly and monthly maturity rates is identified; however, the larger the ARCH(p) and lag-variance(q) value we test, the poorer the performance of the obtained model is. Practical implications ought to be taken into consideration by the banking sector and other financial institutions.

Banks and Negative Interest Rates

In this article, we review the nascent literature on the transmission of negative policy rates. We discuss the theory of how the transmission depends on bank balance sheets, and how this changes once policy rates become negative. We review the growing evidence that negative policy rates are special because the pass-through to banks’ retail deposit rates is hindered by a zero lower bound. We summarize existing research on the impact of negative rates on banks’ lending and securities portfolios as well as their consequences for the real economy. Finally, we discuss the role of different initial conditions when the policy rate becomes negative, and potential interactions between negative policy rates and other unconventional monetary policies.

Central bank policy announcements and changes in trading behavior: Evidence from bond futures high frequency price data

We present an analytical framework to investigate surprises in financial markets. The framework enables us to simultaneously identify and quantify surprises in security price data. By applying the framework to the tick-by-tick data on Japanese government bond futures prices, we find that the Bank of Japan’s introduction of quantitative and qualitative monetary easing in 2013 was one of the most surprising episodes during the period from 2005 to 2016. We also show that traders’ sensitivity to the Bank’s announcements has strengthened since the introduction of the negative interest rate policy in 2016, whereas their sensitivity to economic indicators and surveys has weakened substantially.

Bank business models, negative policy rates, and prudential regulation

Using data from Italian banks over the period 2011–2017, we study how negative interest rate policy and prudential regulation impact on bank business models. We report four key findings. First, banks shifted into retail- and market-oriented business models. Second, high- and low-deposit banks reduced loans and increased security/liquid assets; only market-oriented banks expanded lending. Third, interest rate income compression induced by negative rates has been substantial for the Italian banking system as a whole, although retail banks seem to have suffered less. Fourth, non-interest incomes played a compensatory effect. The portfolio reshuffling, as we observed for wholesale and retail banks (less lending and more securities/liquid assets), is related to the goal of reducing risk exposures and, in turn, the connected capital absorption required by prudential regulation.

The lacking interest in interest rates: will the phase-out of LIBOR and negative rates go unnoticed by arbitration practitioners?

Abstract Interest plays a crucial role in ensuring that the compensation obtained by the winning party does not diminish throughout the many years between the breach and enforcement of the award. Despite its importance, interest is often the last element considered by arbitration practitioners, who sometimes rely on popular interest rate benchmarks that worked well in the past. However, some familiar benchmarks might no longer achieve the intended outcome. We have reviewed public investment arbitration awards rendered in 2019–2020 and identified three issues: the use of LIBOR despite its imminent phase-out, the use of benchmarks that have become negative, and the omission of interest from awards rendered in favour of respondent states. While solutions may vary, we discuss mechanisms that may be used to review existing awards, alternative interest rate benchmarks that may replace LIBOR, and floors that might be helpful to deal with negative interest rates. Arbitration practitioners regret to see it when transactional lawyers negotiate arbitration clauses as ‘midnight clauses’. However, it often escapes the arbitration community that it adopts a similar last minute approach to interest rates. It is hoped that this article might help interest rates avoid the fate of being a ‘midnight remedy’.

Should the ECB adjust its strategy in the face of a lower [formula omitted

We address this question using an estimated New Keynesian DSGE model of the Euro Area with trend inflation, imperfect indexation, and a lower bound on the nominal interest rate. In this setup, a decrease in the steady-state real interest rate, r★, increases the probability of hitting the lower bound constraint, which entails significant welfare costs and warrants an adjustment of the monetary policy strategy. Under an unchanged monetary policy rule, an increase in the inflation target of eight tenths the size of the drop in the real natural rate of interest is warranted. Absent an increase in the inflation target, and assuming the effective lower bound prevents the ECB from implementing more aggressive negative interest rate policies, adjusting the monetary strategy requires considering alternative instruments or policy rules, such as committing to make-up for recent, below-target inflation realizations.

On a Neural Network to Extract Implied Information from American Options

Extracting implied information, like volatility and dividend, from observed option prices is a challenging task when dealing with American options, because of the complex-shaped early-exercise regions and the computational costs to solve the corresponding mathematical problem repeatedly. We will employ a data-driven machine learning approach to estimate the Black-Scholes implied volatility and the dividend yield for American options in a fast and robust way. To determine the implied volatility, the inverse function is approximated by an artificial neural network on the effective computational domain of interest, which decouples the offline (training) and online (prediction) stages and thus eliminates the need for an iterative process. In the case of an unknown dividend yield, we formulate the inverse problem as a calibration problem and determine simultaneously the implied volatility and dividend yield. For this, a generic and robust calibration framework, the Calibration Neural Network (CaNN), is introduced to estimate multiple parameters. It is shown that machine learning can be used as an efficient numerical technique to extract implied information from American options, particularly when considering multiple early-exercise regions due to negative interest rates.

Do negative interest rates affect bank risk-taking?

We offer early evidence on the impact of negative interest rate policy (NIRP) on banks’ risk-taking. Our primary result shows banks in NIRP-adopter countries reduce holdings of risky assets by around 10 percentage points following implementation of NIRP in comparison to banks in non-adopter countries. We augment this result by identifying NIRP’s impact on other aspects of banks’ risk-taking behaviour; NIRP is associated with reductions in banks’ loan growth and average loan price (by 3.7 percentage points and 59 basis points) and a rebalancing of asset portfolios towards safer assets. Secondly, we find the NIRP-effect is heterogeneous; post-NIRP risk-taking increases at strongly capitalised banks and at banks operating in less competitive markets that exploit market power to insulate net interest margins and profitability. Our robust empirical evidence supports the “de-leverage” hypothesis which suggests that banks acquire safer, liquid assets to bolster their capital positions rather than searching for value by acquiring riskier assets. We base our evidence on a sample of 2,584 banks from 33 OECD countries across 2012 to 2016, and from models that employ a difference-in-differences framework. • Negative interest rate policy per se does not increase bank risk-taking. • In NIRP adopting countries banks constrain risk-taking preferring safer liquid assets. • The NIRP effect is heterogeneous. • Better capitalised banks increase risk-taking post NIRP. • Banks operating in less competitive markets increase risk-taking post NIRP.

The channels of banks’ response to negative interest rates

Faced with a potential zero lower bound on 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 3637 banks in 59 countries from 2011 to 2018. We find that the decrease in interest income due to negative interest rates is mitigated by an increase in non-interest income, but only partially. We find that banks respond 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 they adjust their response as negative interest rates persist over time such that how long negative interest rates are implemented matters. Finally, our results suggest that large banks with higher deposits and higher leverage ratios are the most affected by the implementation of negative interest rates.

Monetary policy strategies for the European Central Bank

We develop a behavioral DSGE model which addresses the forward guidance puzzle. We then use the estimated model to assess if unconventional monetary policy tools such as negative interest rates, forward guidance, and asset purchases can provide efficient macroeconomic stabilization in a low nominal and real interest rate environment. While these tools boost output and inflation, the rebound from deep recession can still be painfully slow. Makeup strategies, including average inflation and price level targeting, can further support recovery and reduce downside risks, though the benefits are quite modest under behavioral expectations.

Impacts of Sovereign Risk Premium on Bank Profitability: Evidence from Euro Area

We analyse the effects of sovereign risk premium on bank profitability amongst 154 Eurozone banks during the period 2005 – 2019. In contrast to some of the results in the previous literature, we find that the euro area banks have not suffered too much from the extremely low and negative interest rate era regarding their net internet margins. However, the overall profitability has lowered clearly during the sample period, and the sovereign risk premium has a robust negative effect on all the overall profitability measures, both with risk-adjustment and without it, but it seems to have an increasing effect on the degree of wholesale funding and loan loss provisions. Hence, the profitability puzzle can be explained by a shift towards low-cost wholesale-based funding. Banks have also exercised more loan loss provisions because of the increment in overall risk of the economy. However, if the negative interest rate era still prevails for long, the banking sector faces serious problems based on our results.

Negative interest rate policy (NIRP): history and arguments for and against

The paper deals with the history and the main pro and con arguments of an unconventional monetary policy used by a central bank or another monetary authority that falls out of line with traditional measures. Until recently, the introduction of negative interest rates was unthinkable in the economic practice. From the point of view of economists, there is no unified opinion on this unconventional monetary policy, and there are different attitudes and policies of central banks. Thus, this paper contains not only arguments for, but also arguments against, and compares the two opposing views on the negative interest rate policy. There is a debate on effective macroeconomic policy instruments and some pitfalls can be observed also at the scientific level.

A revised version of the Cathcart & El-Jahel model and its application to CDS market

The paper considers the pricing of credit default swaps (CDSs) using a revised version of the credit risk model proposed in Cathcart and El-Jahel (2003). Default occurs either the first time a signaling process breaches a threshold barrier or unexpectedly at the first jump of a Cox process. The intensity of default depends on the risk-free interest rate, which follows a Vasicek process, instead of a Cox-Ingersoll-Ross process as in the original model. This offers two advantages. On the one hand, it allows us to account for negative interest rates which are recently observed, on the other hand, it simplifies the formula for pricing CDSs. The goodness of fit of the model is tested using a dataset of CDS credit spreads related to European companies. The results obtained show a rather satisfactory agreement between theoretical predictions and market data, which is identical to the one obtained with the original model. In addition, the values of the calibrated parameters result to be stable over time and the semi-closed form solution ensures a very fast implementation.

Central bank interest policy: conceptual concepts and socio-economic context

The article reveals the goals and mechanisms of the interest rate policy of the central bank. The role of the discount rate in ensuring financial and macroeconomic stability is shown. The Taylor rule is presented and justified in a modified form, by including the money supply parameter in it. The phenomenon of negative interest rates is revealed.