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HomeBankAdapting lending insurance policies in a ‘negative-for-long’ situation – Financial institution Underground

Adapting lending insurance policies in a ‘negative-for-long’ situation – Financial institution Underground


Miguel García-Posada and Sergio Mayordomo

In February, the Financial institution hosted its inaugural Financial institution of England Agenda for Analysis (BEAR) convention, with the theme of ‘The Financial Toolkit’. As a part of our occasional sequence of Visitor Posts by exterior presenters at Financial institution analysis occasions, the authors of 1 paper from the BEAR convention define their findings on the impact of unfavorable charges on Spanish banks…

Over the previous decade, a number of central banks have lower coverage charges beneath zero. These are unlikely to work in the identical vogue as charge cuts in constructive territory, due to difficulties with charging unfavorable rates of interest on retail deposits, and due to banks’ unfavorable return on extra liquidity. In a latest paper we discover the impact on financial institution lending by combining knowledge on publicity to unfavorable charges with banks’ stability sheets, the Spanish credit score register and corporations’ stability sheets. We discover it was solely after a number of years of unfavorable charges, when deposit charges reached zero, that affected banks started to lower credit score provide and elevated mortgage charges. This impact was particularly robust for undercapitalised banks and lending to dangerous corporations.

Why would possibly unfavorable charges work in another way?

Financial principle suggests the impact on financial institution lending of charge cuts in unfavorable territory may go both means. One the one hand, it’s effectively documented that the existence of money in its place retailer of worth means it could be troublesome for banks to set unfavorable charges on deposits (eg Heider et al (2019)Eggertsson et al (2020)). This squeezes the web curiosity earnings of banks with a excessive deposit share: retail deposit charges are caught at zero, whereas the remainder of liabilities (eg wholesale funding) and belongings (eg floating-rate loans) are repriced at a decrease degree.

Alternatively, as a result of banks with extra liquidity earn a unfavorable return, they’ve incentives to extend their lending to the non-public non-financial sector in a bid to cut back their extra liquidity holdings (eg Basten and Mariathasan (2018); Demiralp et al (2019)). This portfolio-rebalancing channel might suggest increased threat taking, as risk-free extra liquidity is transformed into financial institution lending.

The evaluation of the influence of unfavorable rates of interest on banks’ credit score provide and threat taking is prone to depend upon the time over which coverage charges are unfavorable. A ‘negative-for-long’ situation would possibly look fairly totally different to a shorter spell of charges beneath zero. As documented by Eggertsson et al (2020), unfavorable charges might have contractionary results solely when retail deposit charges attain the zero decrease sure (ZLB).

Estimating the impact of unfavorable charges on Spanish banks

We examine the impact of the ECB’s unfavorable deposit facility charge (DFR) on the provision of credit score by Spanish banks to non-financial firms throughout a protracted time interval, 2014–19. Spain offers a very good case examine right here due to publicity to unfavorable coverage charges, mixed with a lovely dataset which is right for figuring out the results of unfavorable charges on financial institution lending. As well as, deposit charges in Spain have been effectively above the ZLB when unfavorable rates of interest have been launched within the euro space and it took them a number of years to achieve the ZLB, which offers a great alternative to check the results of a ‘negative-for-long’ situation on credit score provide. To do that, we construct a singular dataset that includes the universe of loans granted to Spanish corporations from the Credit score Register of the Financial institution of Spain, banks’ and corporations’ stability sheets and confidential survey knowledge from the ECB’s Financial institution Lending Survey (BLS).

The BLS is a quarterly survey by way of which euro space banks are requested about developments of their respective credit score markets since 2003 (for extra detailed data see Köhler-Ulbrich, Hempell and Scopel (2016)). Our identification technique exploits heterogeneous publicity to unfavorable charges throughout banks. Particularly, we estimate an ‘affected dummy’, which relies on the chance {that a} financial institution is adversely affected by the unfavorable rates of interest (affected for brief), primarily based on the confidential solutions to the BLS. We assume {that a} financial institution is affected, and our ‘affected dummy’ equals 1, if the chance that it stories that the ECB’s unfavorable DFR contributed to a decline in its web curiosity earnings is increased than 75% (ie the median of the distribution of Spanish banks in 2014). Because the literature suggests a number of channels by way of which unfavorable rates of interest have an effect on banks (ie retail deposits, extra liquidity, floating-rate loans, short-term interbank positions), the BLS offers a abstract measure of publicity to them.

We derive the affected dummy from a probit regression the place our dependent variable is a dummy which information if the financial institution reported that the ECB’s unfavorable deposit facility charge contributed to a lower of the financial institution’s web curiosity earnings (NII) up to now six months, and the regressors embody the deposit ratio and the liquidity ratio. As well as, affected banks might have a excessive share of floating-rate loans or short-term loans, that are repriced at a decrease charge following a discount within the official rate of interest. Due to this fact, we additionally embody the burden of mortgage overdrafts and loans with a maturity as much as one yr within the complete inventory of loans, respectively, and management for different financial institution traits akin to solvency, profitability, measurement and Eurosystem borrowing.

Within the second step, we then run regressions utilizing a 3 dimensional (bank-borrower-time) panel, regressing financial institution lending on the remedy variable, firm-time and financial institution particular mounted results.

Banks’ self-assessment of the influence of unfavorable rates of interest on their stability sheets might pose an identification problem, as weak banks might have incentives to strategically misreport their analysis of the coverage in an effort to ‘blame’ it for his or her poor efficiency. Nonetheless, we get hold of comparable ends in a number of robustness analyses solely primarily based on exhausting knowledge, during which we classify banks in response to their deposit ratios or their share of credit score at floating charges.

Importantly, we permit for various results in several durations by interacting our key regressor with time dummies, to investigate the dynamic influence of unfavorable rates of interest between 2014 and 2019, a interval during which deposit charges in Spain exhibited a downward development till reaching the ZLB. We additionally tackle two key identification challenges. First, we disentangle credit score provide from credit score demand by together with firm-time mounted results à la Khwaja and Mian (2008), which means evaluating lending choices of a number of banks to the identical agency inside the similar interval. Second, we management for the potential results of different ECB insurance policies on banks’ credit score provide, such because the focused long-term refinancing operations (TLTROs) and the expanded asset buy programme (APP).

4 key outcomes

First, we discover that affected banks contracted their lending provide to corporations solely over the past sub-sample interval (2018–19), whereas there isn’t a impact in the course of the earlier durations. This consequence could also be defined by the truth that retail deposit charges have been excessive in Spain on the time of the introduction of the unfavorable rates of interest, so they’d loads of room to say no earlier than reaching the ZLB in 2018. Nonetheless, since coverage charges within the euro space have been lowered a number of occasions since 2014, we can not rule out a complementary clarification, specifically that coverage charges reached the reversal charge (Brunnermeier and Koby (2019)), which is the speed at which accommodative financial coverage ‘reverses’ its meant impact and turns into contractionary for lending.

Second, we additionally discover that the impact of unfavorable rates of interest on banks’ credit score provide was heterogeneous and trusted the extent of banks’ capitalisation. Specifically, we observe that affected banks with low capital ratios curtailed their lending provide to corporations, however they solely did so over the past interval 2018–19, when deposit charges reached the ZLB. Therefore, our findings counsel that the reversal charge can be bank-specific and depending on banks’ capitalization ranges.

Third, splitting our pattern into protected and dangerous corporations, we discover that affected low-capitalised banks lowered their credit score provide to dangerous corporations within the final two pattern durations, 2016–18 and 2018–19, though the impact is way stronger within the latter interval. In contrast, there may be solely a slightly vital impact on protected corporations within the final interval, and its measurement is considerably smaller than that for dangerous corporations. Due to this fact, our findings point out that affected low-capitalised banks contracted their credit score provide to dangerous corporations previous to proscribing it to protected corporations and in a better magnitude, arguably as a result of loans to the previous eat extra regulatory capital than exposures to the latter. This proof means that affected low-capitalised banks took much less threat due to their lack of capital buffers to soak up losses and the necessity to meet capital necessities. Fourth, wanting on the influence of the unfavorable rates of interest on corporations’ complete borrowing we discover no proof that corporations whose primary credit score establishment was an affected low-capitalised financial institution skilled a contraction of their complete financial institution credit score. This proof means that the decrease provide of credit score by affected low-capitalised banks was offset by the upper lending provide by non-affected banks, with capability for taking extra dangers due to their increased capital buffers. Due to this fact, whereas the reversal charge is perhaps reached by some affected undercapitalised banks, there gave the impression to be no combination impact on the provision of lending to corporations.


Miguel García-Posada and Sergio Mayordomo work at Banco de España.

If you wish to get in contact, please e mail us at bankunderground@bankofengland.co.uk or depart a remark beneath.

Feedback will solely seem as soon as authorized by a moderator, and are solely revealed the place a full title is equipped. Financial institution Underground is a weblog for Financial institution of England workers to share views that problem – or help – prevailing coverage orthodoxies. The views expressed listed below are these of the authors, and usually are not essentially these of the Financial institution of England, or its coverage committees.

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