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Simple banking: profitability and the yield curve

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  • Piergiorgio Alessandri

    ()
    (Bank of Italy)

  • Benjamin Nelson

    ()
    (Bank of England)

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.

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Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 945.

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Date of creation: Jan 2014
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Handle: RePEc:bdi:wptemi:td_945_14

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Keywords: banking profitability; net interest margin; interest rates;

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Cited by:
  1. Lucia Esposito & Andrea Nobili & Tiziano Ropele, 2013. "The management of interest rate risk during the crisis: evidence from Italian banks," Temi di discussione (Economic working papers) 933, Bank of Italy, Economic Research and International Relations Area.
  2. Burrows, Oliver & Learmonth, David & McKeown, jack & Williams, Richard, 2012. "RAMSI: a top-down stress-testing model developed at the Bank of England," Bank of England Quarterly Bulletin, Bank of England, vol. 52(3), pages 204-212.

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