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Simple banking: profitability and the yield curve

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  • Alessandri, Piergiorgio

    (Bank of England)

  • Nelson, Benjamin

    (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.

Suggested Citation

  • Alessandri, Piergiorgio & Nelson, Benjamin, 2012. "Simple banking: profitability and the yield curve," Bank of England working papers 452, Bank of England.
  • Handle: RePEc:boe:boeewp:0452
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    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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