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Impact of a policy rate cut on bank profitability and financial stability


  • Hwang, Sunjoo


Concerns prevail that a policy rate cut could weaken bank profitability and trigger financial instability. However, banks can sustain relatively high net interest margins with little fluctuation despite a rate cut owing to their dominant position in the deposit market and ability to adjust loan maturity. - By virtue of their market dominance, banks set their deposit rates below the base rate by a fixed percentage, and as such, the former falls within a narrower range than the latter. - Because deposit rates are little exposed to base rate fluctuations, banks are able to increase their share of long-term loans which are unaffected by short-term rate changes. This means that lending rates also fall by a smaller margin. - An empirical analysis found that a 1%p change in the call rate, which moves in line with the base rate, adjusts the deposit and lending rates by 0.53%p and 0.58%p, respectively, indicating that the fluctuation (0.05%p) in the net interest margin is statistically insignificant. Therefore, the possibility of financial instability due to a deterioration in bank profitability on a rate cut by the central bank should not be deemed as a constraint.

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  • Hwang, Sunjoo, 2020. "Impact of a policy rate cut on bank profitability and financial stability," KDI Policy Forum 280, Korea Development Institute (KDI).
  • Handle: RePEc:zbw:kdifor:280
    DOI: 10.22740/

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    References listed on IDEAS

    1. Boivin, Jean & Kiley, Michael T. & Mishkin, Frederic S., 2010. "How Has the Monetary Transmission Mechanism Evolved Over Time?," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 8, pages 369-422, Elsevier.
    2. Itamar Drechsler & Alexi Savov & Philipp Schnabl, 2018. "Banking on Deposits: Maturity Transformation without Interest Rate Risk," NBER Working Papers 24582, National Bureau of Economic Research, Inc.
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