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Martin Brown toolkit of unconventional measures also includes asset-purchase programs aimed at easing credit con- Negative Interest Rates and ditions through a direct impact on long-term borrow- Bank Lending ing rates. In addition, targeted long-term refinance operations are aimed at providing banks with suf- ficient loanable funds to expand lending.1 The role of negative rates in this toolkit can be seen as one of increasing banks’ incentives to expand lending, rather than hoarding loanable funds in the form of Since 2014 four monetary authorities in Europe have central bank reserves. set their nominal reference rates below zero. As an As a knock-on effect of the ECB’s negative inter- instrument of unconventional monetary policy, est rate policy, monetary authorities in Switzerland, negative interest rates should increase aggregate Denmark, and Sweden have also lowered their rates demand by increasing credit supply. The transmis- below zero since 2015 (see Figure 1). This reaction sion of negative rates to real economic activity thus primarily served to prevent a strengthening of the depends crucially on their impact on intermediation respective currencies against the euro with negative activity in the banking sector. How banks adapt their consequences for aggregate demand and price lev- Martin Brown University of asset structure and liability structure also deter- els. As a traditional safe haven of international cap- St. Gallen mines how negative interest rates impact on finan- ital flows (Auer 2015), Switzerland has been particu- cial stability. Recent empirical evidence suggests larly affected by negative rates in the eurozone. The that exposure to negative interest rates leads to an Swiss National Bank (SNB) maintains a policy rate of acceleration of bank lending. However, this is accom- − 0.75 percent in economic conditions that can argu- panied by an increase of risk taking in the banking ably be characterized by steady (albeit low) growth, sector. booming real asset prices, and full employment.2
NEGATIVE RATES AS AN UNCONVENTIONAL POLICY NEGATIVE RATES AND BANK LENDING: THE CREDIT TOOL IN EUROPE CHANNEL OF MONETARY POLICY
Under conventional policy, monetary authorities The interest-rate channel of monetary policy postu- such as the European Central Bank (ECB) influence lates that lower interest rates raise the demand for the conditions for credit activity, and thus aggre- credit by consumers and firms in order to finance gate demand, by steering the money market rate. additional (durable) consumption and investment.3 Conventional monetary policy tools involve setting By comparison, the credit channel of monetary pol- both an upper bound and a lower bound for inter- icy emphasizes that lower policy rates increase the est rates in the money market: central banks set the supply of credit. Hereby multiple, complementary interest rate at which banks can borrow reserves as mechanisms could be at play. First, lower rates lead well as the rate at which banks can deposit reserves. to an increase in the net worth and collateral value
No-arbitrage conditions dictate that the money 1 For an overview of current ECB policy measures, see: https://www. market rate must lie between this upper and lower ecb.europa.eu/mopo/implement/omt/html/index.en.html and https://www.ecb.europa.eu/mopo/implement/omo/tltro/html/ boundary. Open market operations (e.g., repur- index.en.html. chase agreements) allow the central bank to fine- 2 For an up-to-date analysis of business cycle conditions for Swit- zerland, see https://kof.ethz.ch/en/publications/kof-analysen.html. tune the level of the money market rate between 3 For a textbook presentation of the transmission channels of mon- these goalposts. etary policy, see Mishkin (2018). In June 2014, the ECB set its interest rate on (excess) Figure 1 reserves deposited by com- mercial banks below zero EC O er i h e o i facili S O e ee e cer ifica e for the first time. Since then, S O er i h i h e o i the Deposit Facility Rate has O e ee cer ifica e of e o i been gradually lowered from − 0.1 percent to − 0.5 percent. 2 For the ECB, the negative
deposit facility rate is only 1 one instrument of unconven- tional monetary policy aimed 0 at strengthening aggregate demand in order to meet its 1 200 2010 2011 2012 201 201 201 201 inflation target of close to, but a mar a io al a EC Euro ea Ce ral a S S i a io al a S S eri e i a below, 2 percent. The ECB’s Source ech a Mal ho o 201 ifo i u e
18 CESifo Forum 1 / 2020 March Volume 21 FOCUS
of households and firms, thus improving the cred- may be muted as deposit rates reach the nominal itworthiness of (some) bank clients (balance-sheet zero rate. In the extreme case, where all consumers channel). Second, lower interest rates increase the and firms can frictionlessly store cash as a liquid safe supply of loanable funds to banks (bank-lending asset, the supply of bank deposits would be bound channel). Third, lower interest rates strengthen at zero. bank profitability and net worth, allowing banks to Recent evidence by Eggertson et al. (2019) based access market funding at lower costs and/or expand on Swedish data suggests that – on average – nom- their lending in the presence of prudential regulation inal rates on deposits may indeed be bound at zero (bank-balance-sheet channel). (Figure 2, left). However, a more granular analysis In the following I shall focus my attention on by Altavilla et al. (2019) paints a more differentiated the bank-lending channel, the bank-balance-sheet picture. Their data reveals that a considerable share channel, as well as the related ‘deposits channel’ of deposits by nonfinancial corporations in the euro- as proposed by Drechsler et al. (2017 and 2020). zone are priced below zero (Figure 2, right). Together, The objective is to provide a systematic discussion this evidence on deposit pricing in Europe suggests of how negative interest rates could impact on the that the bank-lending channel may be impaired credit channel of monetary policy. under negative policy rates: it is very likely that nega- tive rates are associated with a limited pass-through The Bank-Lending Channel: Deposit Supply and of policy rates to deposit rates. the Compression of Bank Margins A key debate among policymakers is whether the limited pass-through of negative policy rates The bank-lending channel of monetary policy builds to deposit rates leads to a significant compression on the conjecture that (i) the supply of (insured) cus- of bank spreads and lower profitability. The recent tomer deposits to banks increases when the policy empirical evidence is inconclusive on how low/ rate falls,4 and that (ii) banks face frictions in replac- negative policy rates impact on bank profitability. ing customer deposits with other sources of funding. Cross-country evidence by Borio et al. (2017) sug- Thus, when policy rates fall, the supply of loanable gests that lower short-term interest rates are asso- funds to banks increases, enabling an expansion of ciated with lower bank profitability. Claessens et al. credit. Kashyap and Stein (2000) provide evidence (2018) confirm this finding and document that the consistent with a bank-lending channel: they doc- impact of an interest rate decrease on bank profit- ument that less liquid US banks are more likely to ability is stronger when the level of the policy rate expand their lending when interest rates fall. This is already low. By contrast, Altavilla et al. (2018) is especially the case for smaller (and thus arguably provide evidence suggesting that – once the endog- more deposit-dependent) banks. eneity of policy rates is accounted for – there was To what extent could the bank-lending channel no impact of low short-term interest rates on bank be disrupted when policy rates go negative? A wide- profitability in the eurozone over the 2007–2017 spread conjecture is that there is a discontinuity in period. the impact of policy rates on customer deposit sup- ply when policy rates hit negative territory. In partic- The Bank-Balance-Sheet Channel: Interest Rate ular, the pass-through of policy rates to deposit rates Risk and Bank Valuation
4 For a micro-foundation consider e.g., a portfolio model of money The key mechanism behind the bank-balance-sheet demand (Tobin 1958). A large empirical literature documents the interest-rate sensitivity of money holdings (see e.g., Knell and Stix channel of monetary policy is maturity transforma- 2005). tion. Most financial institutions display a positive
Figure 2 From 1 o h erce ile ou ehol Cor ora io 0 From h o 2 h erce ile olic ra e From 2 h erce ile o mea 0 F era e e o i ra e 0 2
0 2 0 2