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RAPPORT

Do negative interest rates make banks less safe?

We study the impact of increasingly negative central bank policy rates on banks’ propensity to become undercapitalized in a financial crisis (‘SRisk’).

Since the onset of the financial crisis in 2007, many central banks have implemented unprecedented standard and non-standard monetary policy measures, lowering key inter- est rates to approximately zero. To stimulate post-crisis economies characterized by low growth and low inflation, some central banks, including the European Central Bank (ECB), have even adopted negative policy rates. The rationale for negative rates is that they pro- vide additional monetary stimulus, and in this way support growth and a return to target inflation.

Negative rates, by stimulating the economy, could be beneficial for financial institutions via an increase in loan demand, improved asset quality, and a reduced riskiness of loans. On the other hand, two main concerns have been voiced by critics of negative policy rates. First, negative rates could also put pressure on the profitability of financial institutions. Banks may therefore lend to riskier borrowers (‘risk shifting’). Second, a ‘search for yield’ among institutional investors could lead to a disproportional demand for high-yielding risky assets. If so, the implied asset price inflation could impair financial stability.

Which types of banks are perceived by markets as more or less risky at negative rates is as yet unclear. In addition, it is currently unknown whether cuts to negative rates are ‘special’, for example because they imply a different financial stability impact than comparable cuts to low but non-negative rates. In this paper we contribute to answering these questions. To do so, we study the risk impact as perceived by markets of three successive deposit facility rate (DFR) cuts by the ECB to negative values, each by 10 basis points (bps) on June 5, 2014, September 4, 2014, and December 3, 2015. Furthermore, we examine whether the impact of these cuts is qualitatively different from an earlier cut of the DFR from 25 bps to zero on July 5, 2012.

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