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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 collection 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 adverse charges on Spanish banks…

Over the previous decade, a number of central banks have minimize coverage charges beneath zero. These are unlikely to work in the identical style as price cuts in optimistic territory, due to difficulties with charging adverse rates of interest on retail deposits, and due to banks’ adverse return on extra liquidity. In a latest paper we discover the impact on financial institution lending by combining knowledge on publicity to adverse charges with banks’ stability sheets, the Spanish credit score register and companies’ stability sheets. We discover it was solely after a number of years of adverse 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 companies.

Why may adverse charges work in another way?

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

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

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

Estimating the impact of adverse charges on Spanish banks

We examine the impact of the ECB’s adverse deposit facility price (DFR) on the availability of credit score by Spanish banks to non-financial companies throughout a protracted time interval, 2014–19. Spain supplies a great case examine right here due to publicity to adverse coverage charges, mixed with a beautiful dataset which is good for figuring out the results of adverse charges on financial institution lending. As well as, deposit charges in Spain have been nicely above the ZLB when adverse rates of interest have been launched within the euro space and it took them a number of years to achieve the ZLB, which supplies a perfect alternative to review the results of a ‘negative-for-long’ situation on credit score provide. To do that, we construct a novel dataset that contains the universe of loans granted to Spanish companies from the Credit score Register of the Financial institution of Spain, banks’ and companies’ 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 info see Köhler-Ulbrich, Hempell and Scopel (2016)). Our identification technique exploits heterogeneous publicity to adverse charges throughout banks. Particularly, we estimate an ‘affected dummy’, which is predicated on the chance {that a} financial institution is adversely affected by the adverse rates of interest (affected for brief), based mostly 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 adverse DFR contributed to a decline in its web curiosity revenue is larger 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 adverse rates of interest have an effect on banks (ie retail deposits, extra liquidity, floating-rate loans, short-term interbank positions), the BLS supplies 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 adverse deposit facility price contributed to a lower of the financial institution’s web curiosity revenue (NII) prior 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 price 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 12 months within the complete inventory of loans, respectively, and management for different financial institution traits reminiscent of solvency, profitability, dimension 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 fastened results.

Banks’ self-assessment of the impression of adverse 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 so as to ‘blame’ it for his or her poor efficiency. Nonetheless, we acquire related leads to a number of robustness analyses solely based mostly on exhausting knowledge, by which we classify banks in response to their deposit ratios or their share of credit score at floating charges.

Importantly, we enable for various results in several durations by interacting our key regressor with time dummies, to investigate the dynamic impression of adverse rates of interest between 2014 and 2019, a interval by which deposit charges in Spain exhibited a downward pattern 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 fastened results à la Khwaja and Mian (2008), which suggests evaluating lending choices of a number of banks to the identical agency throughout 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 companies solely over the last sub-sample interval (2018–19), whereas there isn’t any impact through the earlier durations. This end result could also be defined by the truth that retail deposit charges have been excessive in Spain on the time of the introduction of the adverse rates of interest, so they’d loads of room to say no earlier than reaching the ZLB in 2018. However, since coverage charges within the euro space have been lowered a number of occasions since 2014, we can not rule out a complementary rationalization, particularly that coverage charges reached the reversal price (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 adverse rates of interest on banks’ credit score provide was heterogeneous and relied on the extent of banks’ capitalisation. Particularly, we observe that affected banks with low capital ratios curtailed their lending provide to companies, however they solely did so over the last interval 2018–19, when deposit charges reached the ZLB. Therefore, our findings counsel that the reversal price can be bank-specific and depending on banks’ capitalization ranges.

Third, splitting our pattern into protected and dangerous companies, we discover that affected low-capitalised banks diminished their credit score provide to dangerous companies within the final two pattern durations, 2016–18 and 2018–19, though the impact is far stronger within the latter interval. In contrast, there’s solely a touch vital impact on protected companies within the final interval, and its dimension is considerably smaller than that for dangerous companies. Due to this fact, our findings point out that affected low-capitalised banks contracted their credit score provide to dangerous companies previous to proscribing it to protected companies and in a higher magnitude, arguably as a result of loans to the previous devour 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 impression of the adverse rates of interest on companies’ complete borrowing we discover no proof that firms 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 larger capital buffers. Due to this fact, whereas the reversal price is likely to be reached by some affected undercapitalised banks, there gave the impression to be no mixture impact on the availability of lending to companies.


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

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

Feedback will solely seem as soon as accredited by a moderator, and are solely revealed the place a full identify 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 here are these of the authors, and are usually not essentially these of the Financial institution of England, or its coverage committees.

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