MASARYK UNIVERSITY Faculty of Economics and Administration Field of Study: Finance Impacts of the Zero Interest Rate Environment: Exploring Growth Drivers of Direct Lending in Germany Dissertation Supervisor: Author: Prof. Dr. Dr. habil. Eric Frère Ilja Schaab, M.Sc. Brno, 2020 Abstract The Eurozone’s historically low interest rates affect banks, corporations, and investors in different ways. This dissertation presents an explorative analysis of the behavior of these three groups in the given zero interest rate environment in order to explain the direct lending industry’s considerable growth in Germany. The bank-related results demonstrate that lower intermediation costs within a zero interest rate environment lead to stronger profit growth in the following period. The corporation-related results indicate that key interest rates significantly positively affect companies’ investment behavior, significantly negatively affect their average return on assets, significantly negatively affect their cash holdings, and exert no unambiguous effect on their credit demand. The investor-related results reveal that investors significantly change their behavior in a zero interest rate environment and demonstrably resort to riskier investments, confirming the debate about reaching for yield. Overall, these results indicate an advantageous environment for the growth of the direct lending industry, which was already able to achieve a significant market share in relation to the total corporate lending market and the total investment market in Germany. Keywords: Corporate Direct Lending Industry in Germany Corporate Finance and Investment Strategies Financial Intermediation Zero Interest Rate Environment Zero Yield Bias JEL Codes: E52, G11, G20, G30, G40 I Declaration of Authenticity I hereby declare that the dissertation Impacts of the Zero Interest Rate Environment: Exploring Growth Drivers of Direct Lending in Germany is my own work carried out under the supervision of Prof. Dr. Dr. habil. Eric Frère, and that I have duly acknowledged all sources in accordance with the law, the internal regulations of Masaryk University, and the binding internal documents of Masaryk University and of the Faculty of Economics and Administration. The views expressed in this dissertation are my own and do not necessarily correspond with those of my employer. Essen, 31.05.2020 ___________________ (Signature) II Acknowledgements „Wen die Dankbarkeit geniert, Der ist übel dran; Denke, wer dich erst geführt, Wer für dich getan!” Johann Wolfgang von Goethe (1814, 390) First of all, I would like to express my gratitude to my supervisor Prof. Dr. Dr. habil. Eric Frère for his guidance and encouragement over the last years. During this time, he has not only promoted my academic but also my personal development. Further, I would like to thank Prof. Dr. Svend Reuse who supported me with valuable advice and suggestions for improvement during the preparation of our first joint publication and thereafter. I would like to thank doc. Ing. Martin Svoboda, Ph.D. for his support and valuable guidance that considerably facilitated my cross-border studies and my first participation in the international scientific conference in Brno. My gratitude also goes to Prof. Dr. Alexander Zureck who not only recommended the doctorate program to me but also provided supportive guidance in times of study. Especially the possibility to collect data for one of my empirical studies helped me considerably in the doctoral studies. Finally, I would like to thank my wife and daughter for their love and support on my academic journey. My gratitude also goes to my family and friends for their backing and their patience. Thank you. III Table of Contents List of Abbreviations ..................................................................................................... VII List of Figures ................................................................................................................. XI List of Tables ................................................................................................................. XII List of Symbols ............................................................................................................ XIV List of Formulas .......................................................................................................... XVII 1. Introduction ................................................................................................................... 1 1.1 Key Interest Rates in the Euro Area as the Starting Point of a Problem ................. 1 1.2 Objectives of the Research Project ......................................................................... 2 1.3 Course of Work ....................................................................................................... 3 2. Theoretical Framework of a Zero Key Interest Rate .................................................... 6 2.1 Role of the European Central Bank in the European Economy .............................. 6 2.2 Objective Systems and Options for Action of Central Banks ................................. 8 2.2.1 Instruments of an Expansive or Restrictive Monetary Policy ........................ 11 2.2.2 Crisis Management by the European Central Bank ....................................... 13 2.3 Zero Interest Rates from a Theoretical Point of View .......................................... 15 2.3.1 Pre-Classical Schools of Economic Thought ................................................. 15 2.3.2 Classical Schools of Economic Thought ........................................................ 18 2.3.3 Neoclassical Schools of Economic Thought .................................................. 20 2.3.4 Heterodox Economic Approaches .................................................................. 25 2.3.5 Modern Theories and Microeconomic Approaches ....................................... 30 2.3.6 Liquidity Trap and Zero Lower Bound Problem ............................................ 38 2.4 Theory-Based Hypotheses Conception ................................................................. 39 3. Financial Intermediation in a Zero Interest Rate Environment .................................. 43 3.1 Components of Intermediation Costs .................................................................... 43 3.1.1 Classical Frictions Resolved by Banks ........................................................... 43 3.1.2 Regulatory Framework ................................................................................... 44 3.1.3 Additional Costs Emerging from the Deposit Protection Scheme ................. 46 3.2 Modelling Financial Transactions Using Utility Maximization Problem ............. 47 3.3 Competitive Landscape in the German Banking Industry .................................... 49 3.3.1 Three-Pillar System ........................................................................................ 49 3.3.2 Margin Development in Zero Interest Rate Environment .............................. 50 3.3.3 Market Participants Utilizing Intermediation-Light Environments ............... 51 3.4 Direct Lending ...................................................................................................... 56 3.4.1 Definition and European Development .......................................................... 56 3.4.2 Direct Lending in the Context of Asset Allocation ........................................ 57 3.4.3 Status Quo of Empirical Research .................................................................. 58 3.5 Hypotheses Refinement – Banks .......................................................................... 58 IV 4. Corporate Finance in a Zero Interest Rate Environment ............................................ 60 4.1 Investment Decisions under Uncertainty .............................................................. 60 4.2 Financing of an Investment Decision .................................................................... 62 4.2.1 Capital Structure Theories .............................................................................. 62 4.2.2 Financing Sources in Leveraged Transactions ............................................... 66 4.3 Key Interest Rate Impacts on Accounting Practices ............................................. 67 4.3.1 Impact Analysis Focusing the Balance Sheet ................................................. 67 4.3.2 Impact Analysis Focusing the Profit and Loss Statement .............................. 69 4.3.3 Impact Analysis Focusing the Cash Flow Statement ..................................... 70 4.3.4 Discrepancy between IFRS and German-GAAP Accounting ........................ 70 4.4 Selection of IFRS Financials for Empirical Research ........................................... 71 4.5 Hypotheses Refinement – Corporations ................................................................ 72 5. Investor Behavior in Times of Zero Key Interest Rates ............................................. 74 5.1 Asset Allocation in Practice .................................................................................. 74 5.2 Zero Yield Bias ..................................................................................................... 76 5.3 Hypotheses Refinement – Investors ...................................................................... 78 6. Testing the Bank-Related Hypotheses ........................................................................ 79 6.1 Empirical Study: Determinants of Bank Profitability