Fed paper looks at negative rates’ impact on eurozone banks

Making policy rates negative lowers banks’ equity prices, particularly for deposit-intensive institutions, a paper published by the Federal Reserve finds.

Miguel Ampudia and Skander Van den Heuvel look at the effects on eurozone banks of the European Central Bank cutting short-term policy rates.

They find that a policy rate cut of 25 basis points in positive territory boosted eurozone banks’ equity prices by 0.97%. In contrast, a decrease in rates by the same amount in negative territory decreases bank equity prices by 2.0%.

The authors call this the “reversal” effect: once rates pass the zero lower bound, the effect on equity prices reverses.

They find that deposit-intensive banks’ net interest margins declined “markedly” in the low and negative rate environment since the 2008 financial crisis. Margins of banks that are less reliant on deposits, however, remained “more or less constant”, they say.

This is because deposit-intensive banks are more reluctant to charge consumers negative rates. Interest rate earnings fall while funding costs do not fully adjust, the authors find.

“Banks that rely more on deposit funding experience a much larger reversal in the effect of short-term interest rate surprises on their equity values once rates are low or negative,” they say.