How do banks operate in a negative policy rate environment? Bank profitability is threatened by policy rate cuts in negative territory because the zero lower bound on retail deposit rates prevents banks from benefiting from cheaper deposit funding costs. Contrary to some earlier research, this paper finds that banks most affected by negative rates through this retail deposits channel increase their lending relative to less affected banks. The response is limited to mortgage lending, and is driven by banks with high household deposit ratios and banks with high overnight deposit ratios. Overall, net interest margins are unaffected, which implies that the volume effect is large enough to offset the adverse impact on bank profitability. However, the positive effect on lending dissipates as negative rates persist. This suggests that although the "reversal rate" has not been breached, it may creep up over time as banks become more limited in their options to maintain profit margins. The results also point to an important role for bank capitalisation “ net interest margins of relatively highly capitalised banks are squeezed, whereas the net interest margins of less capitalised banks are unaffected. This can be explained by differences in capacity for shock absorbency.
Keywords: negative rates, zero lower bound, bank lending channel, monetary policy Transmission.
JEL classifications: E43, E52, E58, G20, G21.