DP15367 The Reversal Interest Rate: A Critical Review

Author(s): Rafael Repullo
Publication Date: October 2020
Keyword(s): bank market power, Bank profitability, Capital requirements, monetary policy, Negative Interest Rates, reversal rate
JEL(s): E52, G21, L13
Programme Areas: Financial Economics, Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=15367

This paper reviews the analysis in Brunnermeier and Koby (2018), showing that lower monetary policy rates can only lead to lower bank lending if there is a binding capital constraint and the bank is a net investor in debt securities, a condition typically satisfied by high deposit banks. It next notes that BK's capital constraint features the future value of the bank's capital, not the current value as in standard regulation. Then, it sets up an alternative model with a standard capital requirement in which profitability matters because bank capital is endogenously provided by shareholders, showing that in this model there is no reversal rate.