Intermediation Below Zero: Effects of Negative Interest Rates on Banks' Performance and Lending

Abstract

Reducing interest rates below zero may be justified on theoretical grounds while, in practice, it is shown to create a number of distortions and malfunctions in several dimensions of banking and financial markets, which in turn may affect the whole economy. This paper surveys international experience of negative interest rates and the existing theoretical and empirical research of the impact on banks. It also investigates the impact of negative interest rates on the European banking sector using a dataset of 3,155 banks from 36 European countries over 2011–2018. Using a difference-in-differences methodology, we show that banks in negative interest-rate environments experienced a 18.4% decrease in their net interest margins compared to other banks operating in European countries that did not adopt negative interest rates. We also show banks taking more customer deposits are more affected.