Monetary Policy and Bank Profitability, 1870 – 2015

Abstract

What is the effect of monetary policy on bank profitability? This paper uses a new long-run dataset spanning 17 countries and 145 years to address this question. I show that a monetary policy tightening leads to an increase in the spread between lending and deposit rates. But even though spreads go up, bank profitability falls. The disconnect between spreads and profits is driven by a sharp increase in loan losses and a contraction in credit growth. I also show that the profitability effect of monetary policy is highly state dependent. The higher their reliance on mortgage credit and non-deposit funding, the more sensitive banks’ profits are to changes in policy rates. This holds both in the long-run cross-country data and across individual banks in the United States.

Keywords: monetary policy, bank profitability, banking system structure, international policy transmission

JEL Classification: E52, G21, N20, F42