Federal funds rate

• By Johannes Bubeck, Angela Maddaloni and Jos-Luis Peydr[1] How do systemic banks in the euro area react to negative central bank interest rates?
• This article suggests that they do not generally pass negative rates on to their depositors, and that they search for yield by investing in riskier securities.
• Their investments are directed more towards securities issued by the private sector and denominated in dollars in addition to euro.

Introduction

• the interest rate banks receive for depositing money with the central bank overnight.
• Money market rates adjusted accordingly and transferred the impact of negative rates to banks funding costs through the wholesale market, i.e.
• Therefore the effect of negative rates on banks funding costs was not homogeneous across banks and depended on their business model, in particular their reliance on bank deposits.
• As a consequence, it is likely that negative rates have also affected the investment behaviour of banks and their risk-taking choices.
• A recent study by Bubeck, Maddaloni and Peydr (2020) suggests that, after the introduction of negative interest rates, systemic banks in the euro area that rely more on customer deposits invested in riskier securities portfolios.

The transmission of low (negative) central bank interest rates to banks

• A reduction in policy rates by the central bank is immediately transmitted to the general level of short-term interest rates prevailing in the market.
• [2] A reduction in short-term interest rates affects first and foremost the liabilities: as long as banks can immediately pass on lower rates to their liabilities, for example to the interest rates paid to their depositors, the rate cut enables banks to fund themselves at a lower cost.
• Also, the valuation of a banks securities portfolio will generally increase because of lower short-term rates.
• Empirical evidence shows, however, that negative interest rates are somewhat special: namely, banks do not generally pass on negative rates, especially to their retail depositors (see Chart 1).
• Chart 1 Central bank interest rates and market interest rates in the euro area

Negative monetary policy rates and banks’ reach for yield

• [4] For the reasons outlined above, banks with different deposit ratios (deposits to total liabilities) are affected differentially when central bank interest rates reach negative territory.
• This provides a means to identify the effect of negative policy rates on bank risk-taking in securities investment and isolate it from other forces that shape both monetary policy and the investment behaviour of large euro area banks.
• In particular, banks with higher deposit ratios might exhibit a stronger increase in risk-taking in response to negative policy rates.
• (2020) analyse the securities portfolios of banks before and after the implementation of negative rates in June 2014 and compare banks that were more affected by the introduction of negative interest rates (measured through their reliance on deposits) with a control group that was less affected.
• A key contribution of the study is to provide the first comprehensive analysis of the impact of negative rates on the securities portfolios of large banks.
• These portfolio reshufflings in response to the adoption of negative rates point to the existence of additional channels of monetary policy transmission, which work through the securities portfolios of large banking intermediaries.
• The results of the study suggest that banks with higher deposit ratios invested in riskier securities portfolios after the introduction of negative interest rates.
• Banks that are more reliant on customer deposits were more affected by negative rates and reached for higher yields.
• (2020) shows that, after the introduction of negative rates, banks with higher levels of capital appeared to reach for yield more.
• [7] Overall, this is again evidence that high-deposit banks take greater risks after the introduction of negative rates.

Conclusions and policy implications

• The introduction of negative policy rates in several countries in the last few years was a significant and novel development.
• It is therefore crucial to gain a better understanding of how negative rates affect financial intermediaries incentives to take risks.
• High-deposit banks increase securities holdings after the introduction of a negative policy rate more than low-deposit banks and this increase is most pronounced for assets with higher yields.
• (2019) which shows that the banks most affected by negative rates increased risk-taking through their syndicated loan portfolios.
• Other studies based on granular data on national loan portfolios produce somewhat mixed results (see for example Bottero et al., 2019 and Arce et al., 2019).

References