Impact of the NIRP on the European Banks’ Profitability: Empirical Analysis of Three Business Models

Details

Supervisors

Knaepen, Denis

Faculty

Louvain School of Management

Degree label

Master [120] en Ingénieur de gestion

Abstract

Since the great financial crisis, the European Central Bank has designed several accommodative monetary policies to revive the European economy and reach its inflation target. Among those, the negative interest rates have created shockwaves in the financial world. In this master thesis, we aim to assess if the negative interest rate policy has undermined the profitability of European financial institutions and banks residing in Sweden and Denmark. To do so, we have gathered the annual financial statements from 2009 to 2016 of 25 banks located in the European Economic Area. Based on their financial statements, we have assigned financial institutions into three different clusters that represent three different business models: the retail banking, the investment banking and the wholesale banking. We assessed that the average return on equity of the three business models has not been significantly impacted by the introduction of the negative interest rates. Furthermore, the return on equity of the banks analysed has even increased following 2014 (i.e. the introduction year of the NIRP). Indeed, financial institutions have not changed their sources of income throughout the period analysed. Thus, as stated by Benoit Cœuré, retail and wholesale banks generate a higher net income in the short-term thanks to short-term interest rates adjusting more rapidly than the long-term interest rates to a change to interest rates. Furthermore, as the price of assets are inflated by the negative interest rates, the investment banks are generating a larger fee & commission income, which justify the positive evolution of their ROE. However, we observed that the return on equity of retail and wholesale banks has plummeted in 2016. This decrease finds its reason in four observations. Firstly, financial institutions must increase their equity funding to be compliant with the Basel III Accords. Secondly, the loans bearing high interest rates are coming to maturity. Hence, they are replaced by lower interest rate loans which diminish their net interest income. In addition to that, some financial institutions have to pay interests on the loans they granted to customers due to the variable interest rate loans. Thirdly, banks have been reluctant to pass the negative interest rates on the deposit accounts of their customers, which also undermine the net interest margin. Finally, in anticipation of the lower income generation, these banks have performed large restructuring plans in 2016 which bear vast initial costs. Nevertheless, we conclude that the prolonged negative interest rates or a further cut in the deposit facility rate of the ECB could significantly harm the profitability of European financial institutions.