Transmission of Negative Interest Rates: Reversal or Amplification?  

Latest version

Abstract

Negative monetary policy rates have been introduced in various advanced economies since the mid 2010s. Previous studies have shown that banks are hesitant to set negative deposit rates, implying losses in deposit taking that erode equity and eventually have a negative impact on the lending of capital constrained banks. I show that when banks are not constrained by their equity, equilibrium loan rates are lower under negative interest rates in the presence of a deposit ZLB (D-ZLB) than in its absence. Thus, policy rate cuts in negative territory might stimulate the economy even more than in positive territory, provided that sufficiently many banks are not capital constrained. In a calibrated dynamic model, the effect is large and dominates the effect due to equity erosion, with the D-ZLB increasing aggregate loan supply by on average 4% when policy rates are negative.

Featured in the 44th International Banking Library Newsletter.

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.

Fair Value Capital and Bank Solvency over the Monetary Policy Cycle

With Vedant Agarwal.

Latest Version

Abstract

We develop a quantitative general equilibrium model of banks that issue credit-risky loans and hold long-term, default-free government bonds to study how including un- realized gains and losses in regulatory capital affects lending and solvency over the monetary policy cycle. Despite partial hedging from deposit franchises, bond valuation changes shape credit supply. Regulatory accounting rules generate strongly asymmet- rical effects across the monetary cycle: during tightening, fair-value accounting sharply reduces bank failures while only moderately contracting credit; during easing, it ampli- fies credit expansions with smaller increases in failures. Welfare gains from fair-value accounting are modest.