On 5 June 2014, the ECB Governing Council lowered the Deposit Facility (DF) rate to -0.10%. With this decision, the central bank ventured into negative territory for the first time in its history. Shortly after, on 4 September 2014, the DF rate was lowered again to -0.20%. Setting negative rates in 2014 was seen as a bold and controversial move. Since then, the ECB has lowered the DF rate three more times: on 9 December 2015 to −0.30%, on 16 March 2016 to −0.40%, and on 18 September 2019 to -0.50%.
The role of deposit funding in the transmission of negative rates
What is special about the rate cuts into negative territory is that, unlike normal rate cuts, they do not lower all short-term rates alike. While the lower, negative policy rate in mid-2014 transmitted to lower, negative market rates on short-term debt (Eonia, 3-month Euribor, etc.), it did not transmit to lower, negative rates on retail deposits.
Banks in general are eager to lower the rates on household retail deposits (Hannan and Berger 1991), but they are reluctant to offer negative deposit rates.1 The distribution of rates that large euro area banks offer on retail household deposits is truncated at zero (Figure 1). Between end-2013 and end-2014, the distribution shifted to the left – banks lower deposit rates – but it still remained truncated at zero. As a consequence, banks with a lot of deposits do not benefit from a lower cost of funding in the way banks with a lot of market-based funding do. In a recent paper (Heider et al. 2019), we formally introduce this argument and use it for econometric identification. It is also used in empirical work by Demiralp et al. (2019), Amzallag et al. (2018), Bubeck et al. (2019), and Ampudia and Van den Heuvel (2018). Eggertsson et al. (2019) and Porcellacchia (2019) embed this logic in a theoretical macro model.
Figure 1 Banks do not set negative rates on household retail deposits
Note: This figure shows the distribution of overnight deposit rates for households in December 2013 (grey bars) and December 2014 (white bars). The data are taken from the ECB IMIR database, which provides monthly interest-rate data for euro-area banks at the monetary financial institution (MFI) level.
The differential transmission of negative policy rates to market rates of short-term debt and to deposit rates exposes banks differently to negative policy rates depending on their liability structure. Relative to banks with little deposit funding, banks with a lot of deposit funding experience a lower reduction of their cost of funding and, thus, a negative shock to their net worth.2
Negative rates and bank lending
This drop in net worth reduces incentives to monitor loans and investments. It may also induce banks to engage in a ‘search for yield’.3 The relative reduction in net worth of the high-deposit banks implies that these banks have an incentive to increase their risk-taking and to reduce their lending, relative to low-deposit banks. We test this hypothesis using a sample of syndicated loans granted by euro area banks between 2011 and 2015.
Figure 2 illustrates our main finding for bank risk-taking. Risk is measured by the standard deviation of the return on assets (ROA) of the firm that receives the loan, calculated during the five years before the loan is granted. The solid line in Figure 2 represents the average of this risk measure for all loans granted by high-deposit banks, i.e. banks in the top tercile of the distribution of the total deposit ratio (household plus corporate deposits). The dashed line represents the same measure for the banks in the bottom tercile of the distribution. In the period leading up to the introduction of negative policy rates, the risk measure for both high-deposit and low-deposit banks moves in parallel. It decreases, with high-deposit banks that lend to less risky firms than low-deposit banks. This gap closes when policy rates become negative, and the previous trend is eventually reversed, implying significantly greater risk-taking by high-deposit banks after June 2014. Unreported regression estimates confirm these results and imply that a one-standard-deviation increase in the deposit ratio (= 9.45%) translates into a 16% increase in ROA volatility. Further analysis indicates that this result is primarily driven by banks that rely heavily on household deposits. This is fully in line with the idea that the zero lower bound is more binding for household deposits than for corporate deposits.
Figure 2 Under negative rates, banks with more deposits lend to riskier firms
Note: This chart plots the four-month forward-looking (e.g., the June-2014 data point uses data from June to September 2014) average of ROA volatility of both private and publicly listed firms that received loans from euro-area banks in the top (solid line) and bottom tercile (dashed line) of the distribution of the average ratio of deposits over total assets in 2013. For a given loan at date t, the associated ROA volatility is measured as the five-year standard deviation of the borrower firm’s return on assets (ROA, using P&L before tax) from year t − 5 to t − 1.
In line with these results on bank lending, Bubeck et al. (2019) observe that high-deposit banks also rebalance their securities portfolio towards riskier assets when rates become negative. Their findings suggest that high-deposit banks reach for yield via investments in securities issued by the private sector (financial and non-financial) and by issuers residing in the euro area and in other developed countries.
The market also views high-deposit banks as riskier once rates become negative. Their CDS returns increase and their stock returns become more volatile (Heider et al. 2019). The market also perceives a higher likelihood of becoming undercapitalised in case of a financial crisis for banks with a traditional business model (i.e. making loans and issuing deposits) once rates become negative (Lucas et al. 2017).
The risk-taking by high-deposit banks is not necessarily harmful, as it appears to push banks into lending to previously rationed firms. The riskier firms that receive more loans appear to be viable. The riskier firms are not less profitable – they are actually less indebted – and are mostly private firms. After receiving more loans, riskier firms invest more and have a larger wage bill. Moreover, the lending to riskier firms does not lead to higher non-performing loans later on (Bottero et al. 2019).
Figure 3 shows the impact of negative rates on bank lending. With lower negative policy rates, the bank lending channel is weaker for high-deposit banks. While all banks increase their lending after the setting of negative rates, banks with higher deposits-to-assets ratios increase lending less. Because of the reluctance to set negative rates on deposits, banks with a lot of deposits benefit less from the lower policy rate than banks with few deposits. As high-deposit banks benefit less from the lower policy rate, they expand their supply of credit less. Demiralp et al. (2019) interact a bank’s holding of excess liquidity, its deposit ratio, and its business model to find that high-deposit banks lend more as of mid-2014 if they hold more excess liquidity.
Figure 3 Under negative rates, banks with higher deposits-to-assets ratio lend less
Note: This figure shows the evolution of an annual lending index (December 2013 = 100) for the 70 largest euro area banks 2012 and 2015. The split into terciles is based on the deposit-ratio distribution in 2013. For each tercile, the figure shows the annual total loan volume (total loan volume in December 2013 is indexed at 100). All data are taken from SNL Financial.
Our research suggests that bank deposits play a crucial role in the transmission of negative rates. We show how the conventional view of monetary policy transmission through bank net worth and the associated external financial premium, when augmented with banks’ reluctance to charge negative rates on deposits, can explain the transmission of negative policy rates.
When rates turn negative, high-deposit banks have to deal with a reduction in their net worth. As a consequence, they take on more risk and they expand their loan portfolio at a slower pace than low-deposit banks do. The risk taking by high-deposit banks can help relax constraints on credit-constrained firms.
Our results also change the interpretation of the role of deposits as a bank business model characteristic. One typically views high-deposit banks as traditional intermediaries providing most of the lending and being most stable. Negative policy rates have the potential to change the role of these banks for the supply of credit to the real economy.
Altavilla, C, L Burlon, M Giannetti, and S Holton (2019), “Is there a zero lower bound? The effects of negative policy rates on banks and firms”, ECB Working Paper no. 2289.
Amzallag, A, A Calza, D Georgarakos, and J Sousa (2018), “Monetary policy transmission to mortgages in a negative interest rate environment”, ECB Working Paper no. 2243.
Ampudia, M, and S Van den Heuvel (2018), “Monetary policy and bank equity values in a time of low interest rates”, ECB Working Paper no. 2199.
Bottero, M, C Minoiu, J-L Peydro, A Polo, A Presbitero, and E Sette (2019), “Negative policy rates and bank asset allocation: Evidence from the Italian credit and security registers”, IMF Working Paper no. 19/44.
Bubeck, J, A Maddaloni, and J-L Peydro (2019), “Negative monetary policy rates and systemic banks’ risk-taking: Evidence from euro area administrative securities register”, unpublished working paper.
Demiralp, S, J Eisenschmidt, and T Vlassopoulos (2019), “Negative interest rates, excess liquidity and bank business models: Banks’ reaction to unconventional monetary policy in the euro area”, ECB Working Paper no. 2283.
Eggertsson, G, R Juelsrud, L Summers, and E Getz Wold (2019), “Negative nominal interest rates and the bank lending channel”, NBER Working Paper no. 25416.
Hannan, T, and A Berger (1991), “The rigidity of prices: Evidence from the banking industry”, American Economic Review, 81, 938-945.
Heider, F, F Saidi, and G Schepens (2019), “Life below zero: Bank lending under negative policy rates”, Review of Financial Studies, 32 (10), 3728-3761.
Lucas, A, F Nucera, J Schaumburg, and B Schwaab (2017), “Do negative interest rates make banks less safe?”, Economic Letters, 159, 112-115.
Porcellacchia, D (2019), “Negative interest rates and maturity transformation”, unpublished working paper.
 The reason why banks are reluctant to set negative deposit rates probably is their fear of deposit withdrawals. As soon as banks were to charge negative rates on deposits, households would withdraw their money and hold cash instead because cash offers a zero (nominal) return. Only a handful of banks did set negative rates on deposits held by non-financial corporations in mid-2014. Presumably, the cost of withdrawing deposits and holding cash instead is larger for firms than for households. Altavilla et al. (2019) analyse in detail the transmission via negative rates on corporate deposits.
 Ampudia and Van den Heuvel (2018) show that during periods of very low and negative rates, deposit-intensive banks exhibit much larger declines in their equity values in response to negative rate surprises than banks that rely less on deposit funding.
 Unfortunately, the available evidence does not allow distinguishing between these two mechanisms.