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Negative interest rates, excess liquidity and retail deposits: Banks’ reaction to unconventional monetary policy in the euro area

Author

Listed:
  • Selva Demiralp

    () (Department of Economics, Koç University, Istanbul, Turkey)

  • Jens Eisenschmidt

    () (European Central Bank, Frankfurt, Germany)

  • Thomas Vlassopoulos

    () (European Central Bank, Frankfurt, Germany)

Abstract

Negative interest rate policy (NIRP) is associated with a particular friction. The remuneration of banks´ retail deposits tends to be floored at zero, which limits the transmission of policy rate cuts to bank funding costs. We investigate whether this friction affects banks’ reactions under NIRP compared to a standard rate cut in the euro area. We argue that reliance on retail deposit funding and the level of excess liquidity holdings may increase banks’ responsiveness to NIRP. We find evidence that banks highly exposed to NIRP tend to grant more loans, i.e. NIRP is indeed expansionary. This confirms studies pointing to higher risk taking by banks under NIRP and contrasts results that associate NIRP with a contraction in bank loans. Broader coverage of our loan data and the explicit consideration of banks’ excess liquidity holdings are the reasons for this different result compared to some earlier literature. We are the first to document the importance of banks’ excess liquidity holdings for the effectiveness of NIRP, pointing to a strong complementarity of NIRP with central bank liquidity injections, e.g. via asset purchases.

Suggested Citation

  • Selva Demiralp & Jens Eisenschmidt & Thomas Vlassopoulos, 2020. "Negative interest rates, excess liquidity and retail deposits: Banks’ reaction to unconventional monetary policy in the euro area," Koç University-TUSIAD Economic Research Forum Working Papers 1910, Koc University-TUSIAD Economic Research Forum.
  • Handle: RePEc:koc:wpaper:1910
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    Cited by:

    1. Romina Ruprecht, 2020. "Negative interest rates, capital flows and exchange rates," ECON - Working Papers 351, Department of Economics - University of Zurich.
    2. Sá, Ana Isabel & Jorge, José, 2019. "Does the deposits channel work under a low interest rate environment?," Economics Letters, Elsevier, vol. 185(C).
    3. Andrew Lee Smith & Victor J. Valcarcel, 2021. "The Financial Market Effects of Unwinding the Federal Reserve’s Balance Sheet," Research Working Paper RWP 20-23, Federal Reserve Bank of Kansas City.
    4. Rostagno, Massimo & Altavilla, Carlo & Carboni, Giacomo & Lemke, Wolfgang & Motto, Roberto & Saint Guilhem, Arthur & Yiangou, Jonathan, 2019. "A tale of two decades: the ECB’s monetary policy at 20," Working Paper Series 2346, European Central Bank.

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    More about this item

    Keywords

    Negative rates; bank balance sheets; monetary transmission mechanism;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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