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 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 damaging charges on Spanish banks…

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

Financial idea suggests the impact on financial institution lending of charge cuts in damaging territory might go both manner. One the one hand, it’s properly documented that the existence of money as a substitute retailer of worth means it might be tough for banks to set damaging charges on deposits (eg Heider et al (2019)Eggertsson et al (2020)). This squeezes the online 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 degree.

Alternatively, as a result of banks with extra liquidity earn a damaging 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 greater threat taking, as risk-free extra liquidity is transformed into financial institution lending.

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

Estimating the impact of damaging charges on Spanish banks

We research the impact of the ECB’s damaging deposit facility charge (DFR) on the provision of credit score by Spanish banks to non-financial companies throughout a protracted time interval, 2014–19. Spain supplies a very good case research right here due to publicity to damaging coverage charges, mixed with a pretty dataset which is good for figuring out the consequences of damaging charges on financial institution lending. As well as, deposit charges in Spain had been properly above the ZLB when damaging rates of interest had been launched within the euro space and it took them a number of years to succeed in the ZLB, which supplies a really perfect alternative to review the consequences 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 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 damaging charges throughout banks. Particularly, we estimate an ‘affected dummy’, which relies on the likelihood {that a} financial institution is adversely affected by the damaging 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 reviews that the ECB’s damaging DFR contributed to a decline in its web curiosity revenue is greater than 75% (ie the median of the distribution of Spanish banks in 2014). Because the literature suggests a number of channels by which damaging 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 damaging deposit facility charge contributed to a lower of the financial institution’s web curiosity revenue (NII) previously 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 charge 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 12 months 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 fastened results.

Banks’ self-assessment of the impression of damaging 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 the intention to ‘blame’ it for his or her poor efficiency. Nonetheless, we acquire comparable leads to a number of robustness analyses solely primarily based on arduous knowledge, through which we classify banks in accordance with their deposit ratios or their share of credit score at floating charges.

Importantly, we enable for various results in numerous durations by interacting our key regressor with time dummies, to investigate the dynamic impression of damaging rates of interest between 2014 and 2019, a interval through 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 fastened results à la Khwaja and Mian (2008), which means 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 companies solely over the last sub-sample interval (2018–19), whereas there is no such thing as a impact in the course of 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 damaging 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’t rule out a complementary clarification, particularly that coverage charges reached the reversal charge (Brunnermeier and Koby (2019)), which is the speed at which accommodative financial coverage ‘reverses’ its supposed impact and turns into contractionary for lending.

Second, we additionally discover that the impact of damaging 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 companies, however they solely did so over the last interval 2018–19, when deposit charges reached the ZLB. Therefore, our findings counsel that the reversal charge could be bank-specific and depending on banks’ capitalization ranges.

Third, splitting our pattern into secure and dangerous companies, we discover that affected low-capitalised banks lowered their credit score provide to dangerous companies within the final two pattern durations, 2016–18 and 2018–19, though the impact is way stronger within the latter interval. Against this, there’s solely a touch important impact on secure companies within the final interval, and its measurement 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 secure companies 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 threat 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 damaging rates of interest on companies’ whole borrowing we discover no proof that firms whose fundamental 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 greater capital buffers. Subsequently, whereas the reversal charge is perhaps 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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