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16 Rev. Eur. Stud. 1 (2024)

handle is hein.journals/rveurost16 and id is 1 raw text is: Review of European Studies; Vol. 16, No. 1; 2024 ISSN 1918-7173 E-ISSN 1918-7181 Published by Canadian Center of Science and Education Determinants of the Profitability and Stability of Euro Area Banks During the Ice Age of Interest Rates Simone Rossi1, Laura Barbieri1, Andrea Lippi1 Department of Economic and Social Sciences, Universita Cattolica del Sacro Cuore, Piacenza, Italy Correspondence: Simone Rossi, Department of Economic and Social Sciences, Universita Cattolica del Sacro Cuore, Piacenza, Italy Received: December 5, 2023 Accepted: February 17, 2024 Online Published: March 12, 2024 doi:10.5539/res.vl6nlpl URL: https://doi.org/10.5539/res.vl6nlpl Abstract In this paper we analyze the determinants of bank profitability and stability during the period of null or negative policy rates (2012 - 2022) for a large sample of banks established in Euro area countries. The results show that higher capitalization, credit quality and income diversification increase profitability and stability, while other covariates play a role mainly in influencing bank profits, but not bank resilience. Empirical outcomes suggest that the banks specialization has an impact on banks' financial results in periods of null or negative interest rates. Keywords: bank profitability, bank stability, monetary policy, Euro Area 1. Introduction Monetary policy conducted by central banks has a crucial impact on the financial system. The setting of policy rates, in fact, determines key benchmarks for financial markets, which shape the yield curve from the anchor of short-term rates, and for commercial banks, which must decide on lending and borrowing rates for customers. Following the major international financial crisis originating from the bursting of the subprime mortgage bubble, major central banks significantly reduced the level of policy rates. In the Eurozone, the theoretical limit of zero interest rates on bank deposits (Zero Lower Bound - ZLB) was first reached on July 11, 2012, and exceeded in June 2014, when the ECB embarked on the unprecedented path of negative deposit rates (Negative interest rate policy - NIRP), maintaining this approach until the second half of 2022, when rates were first raised back to 0 and then soared to counter the surge in inflation. Hence, for about a decade, Euro area banks have experienced zero or negative deposit rates, while the main refinancing rate has fluctuated between zero and 0.75 percent over the same period. In literature the effect of NIRP on banks' profitability and stability is mainly unclear, both theoretically and empirically. In effect, on the one hand the reduction of policy interest rates can result in a collapse of banks' margin (namely the Net Interest Margin - NIM). As pointed out by several contributions, when the yield curve flattens and the banks adjust lending and borrowing rates for customers downwards, the outcome is likely to be a narrowing NIM (Alessandri and Nelson, 2015; Borio et al., 2017; Claessens et al., 2018): banks are reluctant to push borrowing rates below zero to preserve a sound relationship with customers and this attitude put a floor on the bottom side of interest spreads. Moreover, the behavioral reaction to these declining profits profile can be a soaring risk appetite by the bank managers, with adverse effects on banks' soundness. On the other hand, negative rates are likely to produce an increase in asset values and lower credit risks, with a beneficial effect on bank profitability and stability. In effect, observation of bank profitability dynamics during NIRP period in the Euro Area does not show any collapse in bank profits; monetary accommodation has supported the economy, reducing flows of new non-performing loans, while the growth of financial markets has enabled the generation of streams of non-interest incomes (Lopez et al., 2020). Given this trade-off between positive and negative effects of NIRP on banks profitability and stability, it is not surprising that financial outcomes differed from bank to bank depending on their business model and their specific features (Lopez-Penabad et al., 2022). This paper aims to shed light on these determinants of banks' profitability and soundness, studying a sample of 2,065 banks established in the Euro Area over the period 2012-2022. Compared to previous papers that have been interested in the topic of bank profitability and stability during periods of negative or zero rates, our paper has several distinctive aspects. First, the dataset analyzed covers the entire period of negative or zero rates in the Euro area; moreover, the choice to examine a cohesive monetary area makes the sample 1

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