RDP 2023-05: The Impact of Interest Rates on Bank Profitability: A Retrospective Assessment Using New Cross-country Bank-level Data 3. Literature on Bank Profitability and Interest Rates

There is widespread empirical support that lower interest rates are associated with a decline in banks' NIMs. However, there is less agreement on the impact of monetary policy on overall bank profitability as well as the impact of negative rates.[9] Table A1 summarises some of the existing bank-level studies. One goal of this paper is to bring the best available bank-level data to bear on these questions and tie together the seemingly disparate evidence about the impact on overall profitability and nonlinear effects when short-term interest rates are below zero.

Starting with the impact on banks' interest margins, several studies identify a nonlinear relationship between interest rates and NIMs, with the marginal impact of a cut to the cash rate larger in low interest rate environments – see, for example, Borio et al (2017). A prolonged period of low rates is also found by several studies to have a larger negative effect on margins than a relatively short period – see, for example, Claessens et al (2018).

However, there is less consensus in the literature on the impact of monetary policy on overall profitability. Several country-specific papers find modest effects of lower interest rates on bank profitability – for example, Alessandri and Nelson (2015) for UK banks and Busch and Memmel (2015) for German banks – while larger impacts are reported in cross-country studies – for example, Borio et al (2017). In contrast, other papers find a negligible effect of interest rates on bank profitability. For example, Genay and Podjasek (2014) and Bikker and Vervliet (2018) both find that interest rates have a negligible effect on US banks' profitability, mainly because higher fees and lower LLPs offset downward pressure on NIMs.

In recent years studies have focused specifically on the effect of negative rates on bank profitability, with no common ground established. For Denmark and Sweden, Turk (2016) finds that the profitability of banks was resilient following the introduction of negative interest rates, at least in the short and medium term, as does Basten and Mariathasan (2018) for Swiss banks. Focusing on a large cross-country sample of European and Japanese banks, Lopez, Rose and Spiegel (2020) report that the benign implications of negative rates for bank profitability were because banks were able to offset interest income losses under negative rates with gains in non-interest income, including fees and capital gains. By contrast, Rostagno et al (2019) estimate that euro area bank profitability would have been lower in counterfactual scenarios in which the policy interest rate remained at zero or above. Urbschat (2018), Molyneux, Reghezza and Xie (2019) and Beauregard and Spiegel (2020) find that negative interest rates reduce bank profitability in the longer run, partly because of banks' limited ability to pass on negative rates to depositors or otherwise adjust their business models.


See, for example, Borio et al (2017), Claessens et al (2018), Altavilla et al (2018), Bikker and Vervliet (2018), CGFS (2018) and Beauregard and Spiegel (2020). [9]