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 unfavourable charges on Spanish banks…
Over the previous decade, a number of central banks have lower coverage charges under zero. These are unlikely to work in the identical trend 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 current paper we discover the impact on financial institution lending by combining knowledge on publicity to unfavourable charges with banks’ steadiness sheets, the Spanish credit score register and companies’ steadiness 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 companies.
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 might go both method. One the one hand, it’s effectively documented that the existence of money instead retailer of worth means it could be troublesome for banks to set unfavourable 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 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 non-public 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 threat taking, as risk-free extra liquidity is transformed into financial institution lending.
The evaluation of the influence of unfavourable rates of interest on banks’ credit score provide and threat taking is prone to depend upon the time over which coverage charges are unfavourable. A ‘negative-for-long’ situation would possibly look fairly totally 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 certain (ZLB).
Estimating the impact of unfavourable charges on Spanish banks
We examine the impact of the ECB’s unfavourable deposit facility price (DFR) on the provision of credit score by Spanish banks to non-financial companies throughout a protracted time interval, 2014–19. Spain supplies case examine right here due to publicity to unfavourable coverage charges, mixed with a lovely dataset which is good for figuring out the results of unfavourable charges on financial institution lending. As well as, deposit charges in Spain have been effectively above the ZLB when unfavourable 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 great alternative to check 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’ steadiness 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 data 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 studies that the ECB’s unfavourable DFR contributed to a decline in its internet 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 by way of which unfavourable 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 data if the financial institution reported that the ECB’s unfavourable deposit facility price contributed to a lower of the financial institution’s internet curiosity revenue (NII) up to now six months, and the regressors embody 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. Due to this fact, we additionally embody the burden of mortgage overdrafts and loans with a maturity as much as one yr within the whole inventory of loans, respectively, and management for different financial institution traits equivalent to solvency, profitability, measurement 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 mounted results.
Banks’ self-assessment of the influence of unfavourable rates of interest on their steadiness sheets could pose an identification problem, as weak banks could have incentives to strategically misreport their analysis of the coverage with a view to ‘blame’ it for his or her poor efficiency. Nonetheless, we get hold of related ends in a number of robustness analyses solely primarily based 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 permit for various results in numerous intervals by interacting our key regressor with time dummies, to investigate the dynamic influence of unfavourable rates of interest between 2014 and 2019, a interval by which deposit charges in Spain exhibited a downward development 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 means 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 last sub-sample interval (2018–19), whereas there isn’t a impact in the course of the earlier intervals. This outcome could also be defined by the truth that retail deposit charges have 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. However, since coverage charges within the euro space have been lowered a number of instances since 2014, we can’t 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 unfavourable rates of interest on banks’ credit score provide was heterogeneous and trusted the extent of banks’ capitalisation. Specifically, 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 recommend that the reversal price could 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 lowered 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’s solely a slightly vital impact on protected companies within the final interval, and its measurement 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 limiting it to protected companies and in a better 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, trying on the influence of the unfavourable rates of interest on companies’ whole borrowing we discover no proof that firms whose important credit score establishment was an affected low-capitalised financial institution skilled a contraction of their whole 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. Due to this fact, 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 companies.
Miguel García-Posada and Sergio Mayordomo work at Banco de España.
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