RDP 2023-05: The Impact of Interest Rates on Bank Profitability: A Retrospective Assessment Using New Cross-country Bank-level Data 8. Conclusion

This paper has provided an empirical analysis of the effect of lower interest rates on bank profitability – including differential responses when rates are very low – looking back at the period when central banks lowered interest rates to mitigate the risks of deflation. At the time, particular concerns were raised about possible nonlinear effects of low interest rates in the neighbourhood of the effective and zero lower bounds. Banks tend not to reduce deposit rates below a certain threshold, a threshold which may vary across jurisdictions and over time. Because of this, lower interest rates may significantly affect bank profitability near these bounds and hamper monetary policy transmission. It is therefore of utmost importance for policymakers and researchers to carefully assess the magnitude of this effect.

Based on bank-level data for 10 different countries, we have investigated these effects empirically with a consistent methodology between countries, focusing on different measures and components of profitability (NIM, ROA, Non-II and LLPs). A key takeaway from this investigation is that the effect of a decline in interest rates on bank profitability is small, economically speaking. The immediate effect of a 1 percentage point decrease in the short-term interest rate on NIMs is only 5 basis points. While this hides sizeable cross-country differences (and the long-run effect is closer to 15 basis points), the measured effect is lower than previous estimates.

We find some evidence of nonlinearities in low interest rate environments, but only for a handful of countries in the sample. More importantly perhaps, we find that the effect of low interest rates on ROAs is smaller than on NIMs, suggesting that banks have found ways to offset the effect of lower interest rate margins. In addition, holding interest rates ‘lower for longer’ does not appear to change the results noticeably. Similarly, focusing on the countries that moved interest rates into negative territory yields coefficients that are not economically large. Overall therefore, the evidence presented here points to smaller effects of falling and low policy rates on bank profitability than previously estimated.