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The tipping point: interest rates and financial stability

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  • Porcellacchia, Davide

Abstract

This paper studies how interest rates impact bank stability in a standard banking model. There are two opposite effects. While higher rates widen banks’ interest margins, they also reduce the value of their long-term assets. First, the paper characterizes conditions under which an effect dominates. Second, it shows that banking crises are triggered by interest rates crossing a tipping point. Quantitatively, I find that the effect on interest margins is dominant. Hence, low rates are the threat to bank stability. Moreover, I estimate the tipping point at 0.32% for the US economy in the decade before the Global Financial Crisis. JEL Classification: E43, E50, G21

Suggested Citation

  • Porcellacchia, Davide, 2020. "The tipping point: interest rates and financial stability," Working Paper Series 2447, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20202447
    Note: 3169100
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    References listed on IDEAS

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    Cited by:

    1. 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.
    2. Wang, Olivier, 2020. "Banks, low interest rates, and monetary policy transmission," Working Paper Series 2492, European Central Bank.
    3. Porcellacchia, Davide, 2021. "Low rates and bank stability: the risk of a tipping point," Research Bulletin, European Central Bank, vol. 88.

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    More about this item

    Keywords

    deposit franchise; effective lower bound; financial crisis; maturity mismatch;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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