Unintended
consequence of unconventional stimulus initiative is to stifle domestic demand
as commercial bank profits are squeezed
University
of Bath – August 29, 2019 -- Negative interest rate policies – where nominal
rates are set below zero percent – have been introduced in Europe and Japan to
stimulate flagging economies but research from the University of Bath shows the
unconventional monetary strategy may be doing more harm than good.
Recently,
several major European banks announced plans to pass on negative interest rates
to corporations and wealthy individuals. Since 2012 Japan and six European
economies – the Eurozone, Denmark, Hungary, Norway, Sweden and Switzerland -
introduced negative interest rates, making it costly for commercial banks to
hold their excess reserves with central banks.
Negative
interest rates are supposed to stimulate the domestic economy by facilitating
an increase in the demand for bank loans. In theory this could increase new
capital investment by firms and domestic consumption, via credit creation. But
the research showed bank margins were being squeezed, curbing loan growth and
damaging banking profits.
“This
is a good example of unintended consequences. Our study shows negative interest
rate policy has backfired, particularly in an environment where banks are
already struggling with profitability, slow economic recovery, historically
high levels of non-performing loans, and a post banking-crisis deleveraging
phase,” said Dr. Ru Xie of the university’s School of Management.
“If
bank margins are compressed due to low long term yields, and if there is
limited loan growth, then bank profits will fall accordingly. The decline in profits
can erode bank capital bases and hitherto further limit credit growth, thus
stifling any positive impact on domestic demand from negative interest rate
policy monetary transmission effects,” Xie said.
Xie,
working with researchers from Bangor Business School, the U.S. Department of
the Treasury and the University of Sharjah in United Arab Emirates, identified
new evidence that bank margins and profitability fared worse in countries where
negative interest rates were adopted than in countries that did not pursue this
policy.
The
results also suggested that following the introduction of negative interest
rates, bank lending was weaker than in countries that did not adopt the policy.
This was largely driven by the compressed net interest margin from a long term
low yield.
Xie said negative interest rates also appear to have cancelled out the stimulus impact of other forms of unconventional monetary policy such as quantitative easing.
Xie said negative interest rates also appear to have cancelled out the stimulus impact of other forms of unconventional monetary policy such as quantitative easing.
The
findings of the research projects on Negative Interest Rates were presented at
the International Rome Conference on Money, Banking and Finance and the Bank
and Financial Markets Workshop at Deutsche Bundesbank.
The
research team is Dr Ru Xie, Philip Molyneux from the University of Sharjah,
Alessio Reghezza from Bangor Business School and John Thornton from the U.S.
Department of the Treasury.
The
research papers have been published in the Journal of Banking and Finance, and
the Journal of Financial Services Research.
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