Negative interest rates, excess liquidity and retail deposits: Banks’ reaction to unconventional monetary policy in the euro area

69 Pages Posted: 27 Mar 2017 Last revised: 23 Apr 2021

See all articles by Selva Demiralp

Selva Demiralp

Koc University - Department of Economics

Jens Eisenschmidt

European Central Bank (ECB)

Thomas Vlassopoulos

European Central Bank (ECB)

Date Written: September 24, 2020

Abstract

Negative interest rate policy (NIRP) is associated with a particular friction. The remuneration of banks´ retail deposits tends to be floored at zero, which limits the transmission of policy rate cuts to bank funding costs. We investigate whether this friction affects banks’ reactions under NIRP compared to a standard rate cut in the euro area. We argue that reliance on retail deposit funding and the level of excess liquidity holdings may increase banks’ responsiveness to NIRP. We find evidence that banks highly exposed to NIRP tend to grant more loans, i.e. NIRP is indeed expansionary for the levels of interest rates seen in the euro area so far. This confirms studies pointing to higher risk taking by banks under NIRP and sheds some new light on results that associate NIRP with a contraction in bank loans, albeit in specific market segments. We are the first to document the importance of banks’ excess liquidity holdings for the effectiveness of NIRP, pointing to a strong complementarity of NIRP with central bank liquidity injections, e.g. via asset purchases.

Keywords: Negative rates, bank balance sheets, monetary transmission mechanism

JEL Classification: E43, E52, G11, G21

Suggested Citation

Demiralp, Selva and Eisenschmidt, Jens and Vlassopoulos, Thomas, Negative interest rates, excess liquidity and retail deposits: Banks’ reaction to unconventional monetary policy in the euro area (September 24, 2020). Available at SSRN: https://ssrn.com/abstract=2941377 or http://dx.doi.org/10.2139/ssrn.2941377

Selva Demiralp (Contact Author)

Koc University - Department of Economics ( email )

Rumeli Feneri Yolu
Sariyer 80910 Istanbul
Turkey
+212 338 1842 (Phone)

Jens Eisenschmidt

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Thomas Vlassopoulos

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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