Negative Interest Rates : Forecasting Banks' Profitability in a New Environment

We analyze the consequences of unconventional monetary policy by several central banks on the profitability of banks. In many countries the low interest rate environment has been slowly replaced by a negative interest rate environment. Many articles show that banks' profitability with respect to interest income (measured by net interest margin) declines in a low interest rate environment. However, we are skeptical of extrapolating these findings to a negative environment: While the returns on loans follow the decreasing reference rate, costs of deposits are (legally) floored at zero. To address this non-linearity we first employ an ARIMA model on a bank-by-bank basis for many different interest income drivers using a unique supervisory data set on Austrian banks of around 49,000 observations between 1998 and 2016. Second, we show that net interest margin models underestimate the impact of negative rates. Third, we forecast that a hypothetical reference rate close to -2% poses a substantial burden to banks' profitability