The European Central Bank has implemented a number of unconventional monetary policies
since the financial crisis and the subsequent sovereign debt crisis.
One of the policies involves setting the official rate at which banks can park money at the ECB close to zero, or even below zero.
Was this a wise decision?
The idea of setting the official rate close to or below zero is that banks then have more incentive to *not* put money at the central bank. Rather, it would pay for banks to lend the money out, thus providing more financing to the people and businesses and helping the economy to grow again.
Then again, others argue that low interest rates squeeze the profit opportunities for banks, making them more vulnerable to new economic shocks and risking a new crisis in the financial sector.
In this paper, we investigate how markets percieved the effect of the ECB's decision to impose negative interest rates on the riskiness of banks. In particular, we are interested in whether some bank business models are more prone to the potential negative effects of ECB's policy than others.
We measure riskiness of the banks by well established methodology: the expected amount of capital that has to be injected into a troubled bank in case of an extreme market-wide shock. It is important to consider a situation of extreme market stress, as in that case injecting more capital into a troubled bank is most problematic and hurts most.
We find that policy rate cuts below zero trigger different SRisk responses than an equally-sized cut to zero. There is only weak evidence that large universal banks are affected differently than other banks in the sense that the riskiness of the large banks decreases somewhat more for rate decreases into negative territory.
Download the full Tinbergen Institute working paper here or see the paper's official abstract.