The Impact of Interest Rates on Bank Profitability: A Retrospective Assessment Using New Cross-country Bank-level Data

This paper provides a retrospective assessment of the relationship between bank profitability and interest rates, focusing on the period when rates were very low or negative. To do this we use new confidential bank-level data covering about 1,500 banks operating in 10 banking systems, with most samples spanning the two decades up to the end of 2019. Our analysis confirms the empirical regularity that declining interest rates reduce banks' net interest margins. However, we find a smaller effect than in previous studies: on average across countries, a 100 basis point fall in short-term interest rates results in a 5 basis point decline in net interest margins in the short run. Notably, there are substantial cross-country differences, and, in some cases, the estimated effect is greater. Importantly, the effect of lower interest rates on net interest margins is larger than the effect on assets returns, suggesting that banks can shield overall profitability in the face of lower interest rates. For example, lower interest rates alleviate debt-servicing burdens and are associated with a fall in provisions set aside to cover losses on loans. There is therefore no one-size-fits-all result for the impact of low interest rates on overall profitability: in some jurisdictions banks maintained their level of profitability as the beneficial impact of lower rates on loan-loss provisions and other factors, including an increased focus on cost efficiencies and streamlining business models, materially offset the drag from lower interest margins.