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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 unfavourable charges on Spanish banks…

Over the previous decade, a number of central banks have reduce coverage charges under zero. These are unlikely to work in the identical style as price cuts in constructive territory, due to difficulties with charging unfavourable rates of interest on retail deposits, and due to banks’ unfavourable return on extra liquidity. In a latest paper we discover the impact on financial institution lending by combining knowledge on publicity to unfavourable 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 unfavourable 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 unfavourable charges work in a different way?

Financial concept suggests the impact on financial institution lending of price cuts in unfavourable territory may go both method. One the one hand, it’s effectively documented that the existence of money as a substitute retailer of worth means it might be troublesome for banks to set unfavourable 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 unfavourable return, they’ve incentives to extend their lending to the personal 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 could indicate larger danger taking, as risk-free extra liquidity is transformed into financial institution lending.

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

Estimating the impact of unfavourable charges on Spanish banks

We research the impact of the ECB’s unfavourable deposit facility price (DFR) on the provision of credit score by Spanish banks to non-financial firms throughout a protracted time interval, 2014–19. Spain gives an excellent case research right here due to publicity to unfavourable coverage charges, mixed with a sexy dataset which is right for figuring out the results of unfavourable charges on financial institution lending. As well as, deposit charges in Spain had been effectively above the ZLB when unfavourable rates of interest had been launched within the euro space and it took them a number of years to succeed in the ZLB, which gives a really perfect alternative to review the results of a ‘negative-for-long’ situation on credit score provide. To do that, we construct a singular dataset that contains 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 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 unfavourable charges throughout banks. Particularly, we estimate an ‘affected dummy’, which relies on the likelihood {that a} financial institution is adversely affected by the unfavourable 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 likelihood that it experiences that the ECB’s unfavourable DFR contributed to a decline in its web curiosity earnings is larger than 75% (ie the median of the distribution of Spanish banks in 2014). For the reason that literature suggests a number of channels by which unfavourable rates of interest have an effect on banks (ie retail deposits, extra liquidity, floating-rate loans, short-term interbank positions), the BLS gives 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 data if the financial institution reported that the ECB’s unfavourable deposit facility price contributed to a lower of the financial institution’s web curiosity earnings (NII) prior to now six months, and the regressors embrace the deposit ratio and the liquidity ratio. As well as, affected banks could 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. Subsequently, we additionally embrace the load 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 resembling 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 therapy variable, firm-time and financial institution particular fastened results.

Banks’ self-assessment of the impression of unfavourable rates of interest on their stability sheets could pose an identification problem, as weak banks could have incentives to strategically misreport their analysis of the coverage to be able to ‘blame’ it for his or her poor efficiency. Nevertheless, we acquire comparable leads to a number of robustness analyses solely primarily based on exhausting knowledge, wherein we classify banks based on 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 impression of unfavourable rates of interest between 2014 and 2019, a interval wherein deposit charges in Spain exhibited a downward pattern till reaching the ZLB. We additionally handle 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 selections of a number of banks to the identical agency inside the identical 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 is no such thing as a impact throughout the earlier durations. This end result could also be defined by the truth that retail deposit charges had been excessive in Spain on the time of the introduction of the unfavourable rates of interest, so that they had loads of room to say no earlier than reaching the ZLB in 2018. Nonetheless, since coverage charges within the euro space had been lowered a number of occasions since 2014, we can not rule out a complementary clarification, 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 unfavourable rates of interest on banks’ credit score provide was heterogeneous and relied on 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 recommend that the reversal price could be bank-specific and depending on banks’ capitalization ranges.

Third, splitting our pattern into secure and dangerous corporations, we discover that affected low-capitalised banks diminished their credit score provide to dangerous corporations within the final two pattern durations, 2016–18 and 2018–19, though the impact is far stronger within the latter interval. In contrast, there may be solely a slightly important impact on secure corporations within the final interval, and its dimension is considerably smaller than that for dangerous corporations. Subsequently, our findings point out that affected low-capitalised banks contracted their credit score provide to dangerous corporations previous to limiting it to secure corporations and in a larger 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 danger 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 unfavourable rates of interest on corporations’ 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 because of their larger capital buffers. Subsequently, whereas the reversal price is likely to be reached by some affected undercapitalised banks, there appeared 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 [email protected] or depart a remark under.

Feedback will solely seem as soon as authorised 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 will not be essentially these of the Financial institution of England, or its coverage committees.



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