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Discussion Paper
Low Interest Rates and Bank Profits
The Fed’s December 2015 decision to raise interest rates after an unprecedented seven-year stasis offers a chance to assess the link between interest rates and bank profitability. A key determinant of a bank’s profitability is its net interest margin (NIM)—the gap between an institution’s interest income and interest expense, typically normalized by the average size of its interest-earning assets. The aggregate NIM for the largest U.S. banks reached historic lows in the fourth quarter of 2015, coinciding with the “low for long” interest rate environment in place since the ...
Working Paper
Alternative Models of Interest Rate Pass-Through in Normal and Negative Territory
In the aftermath of the Great Recession, many countries used low or negative policy rates to stimulate the economy. These policies gave rise to a rapidly growing literature that seeks to understand and quantify their impact. A fundamental step when studying the effectiveness of low and negative policy rates is to understand their transmission to loan and deposit rates. This paper proposes two models of pass-through from policy rates to loan and deposit rates that can match important stylized facts while remaining parsimonious. These models can be used to study the transition between positive ...
Working Paper
\"Low-For-Long\" Interest Rates and Banks' Interest Margins and Profitability : Cross-Country Evidence
Interest rates in many advanced economies have been low for almost a decade now and are often expected to remain so. This creates challenges for banks. Using a sample of 3,385 banks from 47 countries from 2005 to 2013, we find that a one percentage point interest rate drop implies an 8 basis points lower net interest margin, with this effect greater (20 basis points) at low rates. Low rates also adversely affect bank profitability, but with more variation. And for each additional year of "low for long", margins and profitability fall by another 9 and 6 basis points, respectively.
Working Paper
Banks, Maturity Transformation, and Monetary Policy
Banks engage in maturity transformation and the term premium compensates them for bearing the associated duration risk. Consistent with this view, I show that banks’ net interest margins and term premia have comoved in the United States over the last decades. On monetary policy announcement days, banks’ stock prices fall in response to an increase in expected future short-term interest rates but rise if term premia increase. These effects are reflected in the response of banks’ net interest margins and amplified for institutions with a larger maturity mismatch. The results reveal that ...
Journal Article
Bank Profitability Rebounds despite Compressed Interest Margins
While traditional sources of U.S. bank revenues have struggled during the pandemic, overall bank profitability has soared. This unusual deviation is largely explained by a substantial decline in banks’ loan loss provisions. Extraordinary policy measures undertaken by the Federal Reserve and U.S. Treasury aided a rebound in financial market conditions and, in turn, reduced projected loan losses. However, this effect is likely to be transitory, suggesting an uncertain future for bank profitability.
Working Paper
Monetary Policy and Bank Equity Values in a Time of Low and Negative Interest Rates
Does banks' exposure to interest rate risk change when interest rates are very low or even negative? Using a high-frequency event study methodology and intraday data, we find that the effect of surprise interest rate cuts announced by the ECB on European bank equity values ? an effect that is normally positive ? has become negative since interest rates in the euro area reached zero and below. Since then, a further unexpected cut of 25 basis points in the short-term policy rate lowered banks' stock prices by about 2% on average, compared to a 1% increase in normal times. In the cross section, ...
Working Paper
Community Bank Performance: How Important are Managers?
Community banks have long played an important role in the U.S. economy, providing loans and other financial services to households and small businesses within their local markets. In recent years, technological and legal developments, as well as changes in the business strategies of larger banks and non-bank financial service providers, have purportedly made it more difficult for community banks to attract and retain customers, and hence to survive. Indeed, the number of community banks and the shares of bank branches, deposits, banking assets, and small business loans held by community banks ...
Working Paper
Why Does the Yield Curve Predict GDP Growth? The Role of Banks
We provide evidence on the effect of the slope of the yield curve on economic activity through bank lending. Using detailed data on banks’ lending activities coupled with term premium shocks identified using high-frequency event study or instrumental variables, we show that a steeper yield curve associated with higher term premiums (rather than higher expected short rates) boosts bank profits and the supply of bank loans. Intuitively, a higher term premium represents greater expected profits on maturity transformation, which is at the core of banks’ business model, and therefore ...
Journal Article
Has the Relationship between Bank Size and Profitability Changed?
Kristen Regehr and Rajdeep Sengupta explore whether the relationship between bank size and profitability changed after the 2007?09 financial crisis.
Working Paper
Making Sense of Negative Nominal Interest Rates
Several advanced economies implemented negative nominal interest rates in the middle of the last decade, seeking to provide further monetary accommodation once cuts in positive territory had been exhausted. Negative rates affect banks in novel ways, mostly because during times of negative policy rates the interest rate that banks pay households on their deposits usually remains close to zero. In this review, we analyze the large literature that studies the impact of negative nominal interest rates, proceeding in four steps. First, we explain the theoretical channels through which negative ...