Recently, several major European banks have announced plans to pass on negative interest rates to corporations and wealthy individuals. Since 2012 six European economies (Denmark, the Eurozone, Hungary, Norway, Sweden and Switzerland) and Japan have all introduced a Negative Interest Rate Policy (NIRP), where nominal interest rates are set below zero percent. This is a relatively new and unconventional monetary policy that makes it costly for commercial banks to hold their excess reserves at central banks.
Negative interest rates are supposed to stimulate the domestic economy by facilitating an increase in the demand for new bank loans/new bank lending. In theory this could raise new capital investment by firms and domestic consumption, via credit creation. However, if bank margins are compressed due to low long term yields, and if there is limited loan growth, then bank profits will fall accordingly. The decline in profits can erode bank capital bases and hitherto further limit credit growth - thus, stifling any positive impact on domestic demand from negative interest rate policy monetary transmission effects. The influence of negative rates on bank performance may further be aggravated when banks are struggling to maintain respectable levels of profitability because of slow economic recovery, historically high levels of non-performing loans, and a post crisis deleveraging phase.
Our research projects have identified new evidence that bank margins and profitability fared worse in countries where negative interest rates were adopted than in countries that did not adopt this policy. Our results also suggest that following the introduction of negative interest rates, bank lending was weaker in adopted countries than in countries that did not adopt the policy, and this was largely driven by the compressed net interest margin from a long term low yield. Negative interest rates also appeas to have cancelled out the stimulus impact of other forms of unconventional monetary policy. According to our research, central bank efforts to push the interest rate below zero percent have backfired, which has had an adverse impact upon bank profitability, credit creation and financial stability. The findings of the research projects on Negative Interest Rates have been presented at the International Rome Conference on Money, Banking and Finance and the Bank and Financial Markets Workshop at Deutsche Bundesbank. Recently, two research papers which explore these issues in greater detail have been accepted for publications in Journal of Banking and Finance and Journal of Financial Services Research.