Transmission of Negative Interest Rates: Reversal or Amplification?  

Latest version

Abstract

Previous studies show that banks avoid passing negative monetary policy rates through to de- positors, causing equity erosion that can constrain lending. This paper identifies a countervailing risk-appetite channel: when the deposit zero lower bound binds, negative rates increase banks’ failure risk, strengthening limited-liability incentives to expand risky lending. Consequently, rate cuts below zero can stimulate loan supply more than cuts in positive territory, provided enough banks are unconstrained. A dynamic model calibrated to Germany, the largest euro area econ- omy, finds this effect substantial, increasing aggregate loan supply by about 9% despite equity erosion pressures.

Featured in the 44th International Banking Library Newsletter.

Fair Value Capital and Bank Solvency over the Monetary Policy Cycle

With Vedant Agarwal.

Latest Version submitted.

Abstract

We develop a quantitative general equilibrium model of banks that issue credit-risky loans and invest in interest rate-sensitive securities to study how including unrealized securities gains and losses in regulatory capital affects lending and solvency over the monetary policy cycle. Regulatory accounting rules generate asymmetric effects across the cycle. During tightening, including valuation changes in regulatory capital substantially reduces bank failures while only moderately contracting credit. During easing, it substantially expands credit while only moderately increasing failures. The asymmetry arises from the interaction of credit and interest rate risk. Welfare gains from incorporating valuation changes are modest.

ECB Euro Liquidity Lines 

With Silvia Albrizio, Iván Kataryniuk and Luis Molina 

Latest version accepted at International Journal of Central Banking. 

Abstract

Central bank liquidity lines have gained importance as a cross-currency liquidity management tool with the intention to prevent threats to financial stability. We provide a complete timeline of ECB liquidity line announcements and quantify their signaling effect. The premium to borrow euros in FX markets is estimated to decrease by 51 basis points upon announcement. Moreover, we test for spillbacks and find that bank stock prices increase by around 2.1% in euro area countries highly exposed via banking linkages to currencies targeted by liquidity lines. The mechanism behind this novel result is illustrated in a stylized bank default model.

VoxEU Article. BdE Research Features.

Supplementary Material: Timeline ECB Liquidity Line Announcements.