European bank margins at the zero lower bound

Post-2014, the zero lower bound on household deposits has intensified the downward pressure of the ECB’s accommodative monetary policy on banks’ net interest margins. Using a shadow rate to capture the stance of (unconventional) monetary policy, we construct counterfactual deposit rates, representing the path that deposit rates in 10 euro area countries would have followed in absence of the zero lower bound. Based on this counterfactual, we investigate whether banks attempt to compensate foregone deposit margins by increasing their lending margins. Our results show a substantial degree of margin compensation (around 44%). Moreover, banks which are highly dependent on net interest income increase their lending margins more, while higher shares of fee and commission income soften the compensation effect. Our estimations reveal important heterogeneity across euro area countries, with the end-2019 impact on lending margins ranging from negligible to more than 100 bps. These findings have implications for bank profitability, but also for the transmission of monetary policy to bank lending.