Monetary easing, liquidity, and profitability: Banks at the zero lower bound during COVID‐19

In March 2020, during the first quarter of the COVID‐19 pandemic, the Federal Reserve System (Fed) in the U.S. took major decisions within the scope of conventional monetary policy by eliminating reserve requirements for banks and bringing the federal funds rate near zero, toward the so‐called zero lower bound (ZLB). In this ZLB environment, the Fed further applied unconventional monetary policy tools in the sense of “monetary easing” to prevent a possible credit crunch and foster bank lending in the pandemic crisis. However, so far, it is unclear how this monetary easing has impacted banks' liquidity and profitability during the period of ZLB environment and COVID‐19. Therefore, we examine how the Fed's monetary easing initiative – measured by the shadow short rate (SSR) – affected banks' liquidity and profitability during the ZLB period of the COVID‐19 pandemic (2020Q1–2021Q4). Using a panel of 87 U.S. commercial banks over eight quarters, we estimate ordinary least squares (OLS), fixed and random effects, system and difference generalized method of moments (GMM), and quantile regression models. We find empirical evidence that expansionary monetary policy pursuing monetary easing, including unconventional monetary policy interventions, decreases banks' liquidity by promoting bank lending compared to deposits and by decreasing the holding of liquid assets compared to total assets. Moreover, monetary easing increases banks' profitability as measured by the return on assets (ROA) and the return on equity (ROE). In other words, deeper easing (i.e., lower SSR) goes together with higher loan‐to‐deposit ratios, lower liquid asset shares, and improved return metrics (ROA, ROE). These results are robust based on two‐step system GMM models and, additionally, two‐step difference GMM models. Moreover, we observe a heterogeneous impact of monetary easing on banks' liquidity and profitability applying quantile regression. Our study provides interesting empirical evidence for policymakers.