The Tipping Point : Interest Rates and Financial Stability

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 threaten bank stability. Moreover, I estimate the tipping point at 0.32% for the US economy in the decade before the Global Financial Crisis