Simple Banking: Profitability and the Yield Curve

55 Pages Posted: 26 Jun 2012

Date Written: June 21, 2012

Abstract

How does bank profitability vary with interest rates? We present a model of a monopolistically competitive bank subject to repricing frictions, and test the model’s predictions using a unique panel data set on UK banks. We find evidence that large banks retain a residual exposure to interest rates, even after accounting for hedging activity operating through the trading book. In the long run, both level and slope of the yield curve contribute positively to profitability. In the short run, however, increases in market rates compress interest margins, consistent with the presence of non negligible loan pricing frictions.

JEL Classification: E4, G21

Suggested Citation

Alessandri, Piergiorgio and Nelson, Benjamin, Simple Banking: Profitability and the Yield Curve (June 21, 2012). Bank of England Working Paper No. 452, Available at SSRN: https://ssrn.com/abstract=2093394 or http://dx.doi.org/10.2139/ssrn.2093394

Piergiorgio Alessandri

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Benjamin Nelson (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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