Funding liquidity regulation, ultra-expansionary monetary policy and European banks’ profitability

By reducing the asset-liability maturity mismatch, the Basel III Net Stable Funding Ratio (NSFR) might have a tremendous impact on banks’ ability to make profits. We show that the joint effect of the adoption of ultra-expansionary measures of monetary policy and this liquidity requirement can seriously threaten banks’ profitability in terms of their net interest margins. Based on a panel dataset of European banks observed over the 2011–2018 years, we find that the level and the dynamics of interest rates affect the relationship between NSFR and banks’ profits. The impact of the NSFR is null during the years 2011–2012, when market rates firstly raise and then decline, which suggests that, when rates show a certain volatility, the decrease in the funding cost due to a lower exposure to funding liquidity risk more than offsets the drawback of lower interest earnings. This result does not hold for the years 2013–2018, when interest rates stay close to the zero level and, finally, become negative, but with a much more stable trend. We argue that the higher level of interest rates in the years 2011–2012 gives banks the room to negotiate more profitable conditions with the clientele following the changes in market rates observed during those years. The proximity to the zero level of the interest rates and their stability remove or significantly limit that possibility and can explain the negative impact of the NSFR on banks’ net interest margins.