Low interest rates put pressure on banks’ interest margin

Interest rates have been low for a considerable period of time. We have repeatedly pointed out that persistently low interest rates are putting pressure on banks’ interest margin – the difference between their interest income and their interest expense as a percentage of total assets. Banks have not fully passed on lower market rates to the interest rates on deposits – and on household deposits in particular. At the same time, their lending rates – on mortgages, for example – did decrease in line with market rates. As a result, banks’ borrowing rates have decreased less than their lending rates, putting their interest margin under pressure. However, banks also benefit from low interest rates through other channels. For example, lower interest rates improve debtors’ ability to repay, reducing credit risk.

Dutch banks managed to maintain their interest margin for a long time. One reason is that a fall in interest rates has a delayed impact on banks’ balance sheets. Until the banks’ old loan contracts mature, it will take some time for lower interest rates to be fully passed on to their outstanding portfolios. In addition, Dutch banks have benefited from the sharp decline in market funding costs, and ECB measures have mitigated the impact of negative interest rates. For example, a share of the reserves that banks hold with the central bank is exempt from the negative deposit facility rate, and banks can obtain cheap funding through the targeted longer-term refinancing operations (TLTRO) programme.

Fall in Dutch banks' interest margin

After three years of stability, the interest margin of Dutch banks fell to 1.23% over the past year (Figure 1). While this is still above pre-2013 levels, it poses the question as to whether this signals the start of a downward trend. We cannot confirm this with certainty, but the pressure on the interest margin is expected to persist for the time being. Despite the recent increase in market rates, interest levels remain low. In addition, as with a fall in interest rates, it will take some time before the impact of a possible further interest rate increase will become fully visible in the interest margin.

Banks are increasingly charging negative interest rates

In response to the ECB's negative policy rate and negative market rates, banks increasingly pass on negative interest rates to their customers. For example, some large Dutch banks have further lowered the threshold above which they apply negative savings rates to €100,000 or €150,000. While this affects an increasing proportion of savings, at the moment the majority of households are not yet confronted with negative savings rates, since over 97% of Dutch savings accounts have a balance of less than €100,000.