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Banks, Low Interest Rates, and Monetary Policy Transmission

Author

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  • OLIVIER WANG

Abstract

I study how the secular decline in interest rates affects banks' intermediation spreads and credit supply. Following a permanent decrease in rates, bank lending may rise initially but contracts in the long run. As lower rates compress deposit spreads even well above the zero lower bound, banks' retained earnings, equity, and lending fall until loan spreads have risen enough to offset the reduction in deposit spreads. A higher inflation target can support bank lending at the cost of higher liquidity premia. I find support for the model's predictions in U.S. aggregate and bank‐level data.

Suggested Citation

  • Olivier Wang, 2025. "Banks, Low Interest Rates, and Monetary Policy Transmission," Journal of Finance, American Finance Association, vol. 80(3), pages 1379-1416, June.
    • Handle: RePEc:bla:jfinan:v:80:y:2025:i:3:p:1379-1416
    DOI: 10.1111/jofi.13436
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    Cited by:

    1. Berentsen, Aleksander & van Buggenum, Hugo & Ruprecht, Romina, 2025. "On the negatives of negative interest rates," European Economic Review, Elsevier, vol. 178(C).
    2. Goodhart, Charles A.E. & Tsomocos, Dimitrios P. & Wang, Xuan, 2023. "Bank credit, inflation, and default risks over an infinite horizon," Journal of Financial Stability, Elsevier, vol. 67(C).
    3. Fan Liang, 2026. "Adverse Selection and Small Business Finances," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 61, August.
    4. Florian Heider & Farzad Saidi & Glenn Schepens, 2021. "Banks and Negative Interest Rates," Annual Review of Financial Economics, Annual Reviews, vol. 13(1), pages 201-218, November.
    5. Head, Allen & Kam, Timothy & Ng, Sam & Pan, Guangqian, 2025. "Money and imperfectly competitive credit," Journal of Economic Theory, Elsevier, vol. 228(C).
    6. Yan Ji & Songyuan Teng & Robert Townsend, 2021. "Dynamic Bank Expansion: Spatial Growth, Financial Access, and Inequality," NBER Working Papers 28582, National Bureau of Economic Research, Inc.
    7. repec:ecb:ecbdps:202116 is not listed on IDEAS
    8. Mauricio Ulate, 2021. "Alternative Models of Interest Rate Pass-Through in Normal and Negative Territory," International Journal of Central Banking, International Journal of Central Banking, vol. 17(1), pages 3-34, March.
    9. Petr Wawrosz & Semen Traksel, 2023. "Negative Interest Rates and Its Impact on GDP, FDI and Banks’ Financial Performance: The Cases of Switzerland and Sweden," IJFS, MDPI, vol. 11(2), pages 1-23, May.
    10. Jermann, Urban & Xiang, Haotian, 2023. "Dynamic banking with non-maturing deposits," Journal of Economic Theory, Elsevier, vol. 209(C).
    11. Heider, Florian & Leonello, Agnese, 2021. "Monetary Policy in a Low Interest Rate Environment: Reversal Rate and Risk-Taking," Working Paper Series 2593, European Central Bank.
    12. Aleksander Berentsen & Romina Ruprecht & Hugo van Buggenum, 2023. "On the Negatives of Negative Interest Rates," Finance and Economics Discussion Series 2023-064, Board of Governors of the Federal Reserve System (U.S.).
    13. Present, Thomas & Simoens, Mathieu & Vander Vennet, Rudi, 2023. "European bank margins at the zero lower bound," Journal of International Money and Finance, Elsevier, vol. 131(C).
    14. Francesco D'Acunto & Daniel Hoang & Maritta Paloviita & Michael Weber, 2019. "Human Frictions to the Transmission of Economic Policy," 2019 Meeting Papers 339, Society for Economic Dynamics.
    15. Mohammad Tahir Zainuddin & Wan Nur Fazni Wan Mohamad Nazarie & Ratna Roostika & Nofrizal Nofrizal, 2026. "Understanding Gen Z Consumers’ Behaviour in Digital Banking Adoption: An Empirical Study," International Journal of Research and Innovation in Social Science, International Journal of Research and Innovation in Social Science (IJRISS), vol. 10(5), pages 189-203, May.
    16. Alberto Polo, 2021. "Imperfect pass-through to deposit rates and monetary policy transmission," Bank of England Staff Working Paper series 933, Bank of England.
    17. Abad, Jorge & Nuño, Galo & Thomas, Carlos, 2025. "CBDC and the operational framework of monetary policy," Journal of Monetary Economics, Elsevier, vol. 151(C).
    18. Van Nieuwerburgh, Stijn & Elenev, Vadim & Landvoigt, Tim & Shultz, Patrick, 2021. "Can Monetary Policy Create Fiscal Capacity?," CEPR Discussion Papers 16414, Centre for Economic Policy Research.
    19. Majid Zubair Ahmed & Muhammad Akram, 2026. "Digitalization and Financial Stability: A Comparative Analysis of Islamic and Conventional Banks in Pakistan," Journal of Economic Sciences, Federal Urdu University Islamabad, Department of Economics, vol. 5(1), pages 49-70, January-J.

    More about this item

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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