26 Nov 2016

How do low and negative interest rates affect banks’ profitability in the euro area?

Daniel Gros

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Critics of ECB loose monetary policy warn against the risk that this policy squeezes banks’ profits, which could ultimately lead to higher lending rates and lower credit supply. This discussion has arisen in the euro area in particular, as banks’ profitability is low on average and some banks are burdened by a huge amount of non-performing loans. By extension, it is argued, low or negative interest rates impair the transmission mechanism of monetary policy. At the same time, however, the demand for loans increases at low interest rates, which can lead to larger lending volumes and thus improve earnings. Obviously, there is no unequivocal effect on banks’ profitability ability from low/negative interest rates per se. Other problems such as a large proportion of bad loans, high operational/management costs and low productivity may play an important role in explaining the weak profitability of euro area banks. The notes in this compilation provide an assessment of these different effects.

The notes have been requested by the Committee on Economic and Monetary Affairs as an input for the November 2016 session of the Monetary Dialogue.