Bank capital and monetary policy transmission

Panel remarks by Mr Hyun Song Shin, Economic Adviser and Head of Research of the BIS, at The ECB and its Watchers XVII conference, Frankfurt, 7 April 2016.

Standard macroeconomic models make little explicit mention of banks. While this is an acceptable simplification normally, it may neglect important details in the current economic environment, especially with respect to negative interest rates. How banks manage their balance sheets has implications for monetary policy as well as for financial stability. Recent BIS research supports the notion that soundly capitalised banks enjoy lower funding costs and lend more. But a sample of 90 euro area banks reveals that retained earnings, a key source of bank capital, would have been 75% higher had profits been ploughed back into the banks. Negative interest rates may weaken bank profitability, given that deposit rates rarely follow policy rates below zero. Thus, bank funding costs may not fall much, if at all, below zero. The usual relationship that lower interest rates engender more lending may break down when market rates turn negative. A better understanding of banks' funding methods - which vary greatly worldwide - is therefore important when assessing the likely macroeconomic outcomes of monetary policy initiatives.