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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 lower coverage charges beneath zero. These are unlikely to work in the identical vogue as price cuts in constructive 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 would possibly adverse charges work otherwise?
Financial concept 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 in its place retailer of worth means it could be tough 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 stage.
Alternatively, 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 could indicate increased danger 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 danger taking is more likely to depend upon the time over which coverage charges are adverse. 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), adverse charges could have contractionary results solely when retail deposit charges attain the zero decrease certain (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 offers a superb case examine right here due to publicity to adverse coverage charges, mixed with a lovely dataset which is right for figuring out the results of adverse charges on financial institution lending. As well as, deposit charges in Spain had been nicely above the ZLB when adverse rates of interest had been launched within the euro space and it took them a number of years to succeed in 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 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 via 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 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 increased than 75% (ie the median of the distribution of Spanish banks in 2014). Because the literature suggests a number of channels via which adverse 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 data 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) up 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 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 corresponding to 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 mounted results.
Banks’ self-assessment of the impression of adverse 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 so as to ‘blame’ it for his or her poor efficiency. Nevertheless, we get hold of related leads to a number of robustness analyses solely based mostly on laborious knowledge, wherein we classify banks based on their deposit ratios or their share of credit score at floating charges.
Importantly, we enable for various results in numerous intervals by interacting our key regressor with time dummies, to investigate the dynamic impression of adverse rates of interest between 2014 and 2019, a interval wherein 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 mounted results à la Khwaja and Mian (2008), which suggests 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 companies solely over the past sub-sample interval (2018–19), whereas there isn’t a impact through the earlier intervals. This outcome could also be defined by the truth that retail deposit charges had 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. 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 adverse rates of interest on banks’ credit score provide was heterogeneous and trusted 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 past 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 intervals, 2016–18 and 2018–19, though the impact is far stronger within the latter interval. Against this, there may be solely a touch important impact on protected companies within the final interval, and its dimension is considerably smaller than that for dangerous companies. Subsequently, our findings point out that affected low-capitalised banks contracted their credit score provide to dangerous companies previous to limiting it to protected companies and in a larger 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 danger due to their lack of capital buffers to soak up losses and the necessity to meet capital necessities. Fourth, trying on the impression of the adverse rates of interest on companies’ complete borrowing we discover no proof that firms whose essential 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 increased capital buffers. Subsequently, whereas the reversal price is likely to be reached by some affected undercapitalised banks, there appeared to be no mixture impact on the availability of lending to companies.
Miguel García-Posada and Sergio Mayordomo work at Banco de España.
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