Euro area unconventional monetary policy and bank resilience

Summary

Focus

The ECB has deployed a broad array of unconventional monetary policy tools over the last few years. Those include negative interest rates, and several programmes of asset purchases and long-term liquidity provision, which we bundle together under the general label of "quantitative easing". We study the impact of these measures on the "resilience" of banks in the euro area. We characterise the bank level resilience in terms of the size of a shock to profitability, as measured by returns on assets, which a bank can withstand without wiping out its loss-absorbing buffers.

Contribution

Unconventional monetary policy tools have the purpose of supporting the economy and providing further stimulus at times when the effectiveness of conventional tools appears exhausted, in particular when the policy interest rate is reaching the zero-lower bound (ZLB). There is a lively debate about the role that unconventional tools have had, and what would that role be in future policymaking. That debate encloses, in part, an assessment of the actual costs and benefits of these tools. This paper contributes to that debate by shedding light on the effect that unconventional tools have on bank resilience, and thereby on financial stability. This is admittedly a side effect of these tools but a full cost-benefit analysis should not ignore this kind of effect. In this paper, we primarily address this issue using balance sheet data for a large sample of euro area banks.

Findings

Overall our results suggest that, away from the ZLB, lower interest rates tend to weaken banks' loss absorbing buffers. However we show that, as interest rates approach the ZLB or turn negative, further reductions actually enhance buffers, as a result of non-linearities around the ZLB. Quantitative easing would strengthen bank buffers overall, supporting the financial stability of the euro area. These findings expose the underlying complexities when it comes to disentangle the effects of monetary policy tools in the euro area. We also report that the benefits of improved resilience would have accrued mostly to banks headquartered in the core of the euro area. Banks based on the member states hardest hit by the 2011 sovereign debt crisis appeared to become less resilient as a result of these policies during our sample period.

Abstract

This paper examines whether euro area unconventional monetary policies have affected the loss-absorbing buffers (that is the resilience) of the banking industry. We employ various measures to capture the effect of the broad array of programmes used by the ECB to implement balance sheet policies, while we control for the effect of conventional and negative (or very low) interest rate policy. The results suggest that, above and away from the zero-lower bound, looser interest rate policy tends to weaken our measure of euro area banks' loss-absorbing buffers. On the contrary, further lowering interest rates near and below the zero lower bound seems to strengthen (or weaken less) such buffers, which points towards non-linearities arising in the vicinity of the lower bound. Moreover, balance sheet easing policies enhance bank level resilience overall. However, unconventional monetary policies seem to have increased the fragility of banks in the member states hardest hit by the 2011 sovereign debt crisis. In fact, the evidence presented in this paper suggest that the resilience gains of unconventional monetary policies have accrued mostly to banks headquartered in the so-called core euro area countries (Austria, Belgium, Finland, France, Germany, Luxembourg and Netherlands). Finally, unconventional monetary policies seem to have enhanced more the resilience of banks that were relatively stronger, i.e. that were in the higher deciles of the distribution of loss-absorbing buffers.

JEL classification: G21, E52, E43

Keywords: Unconventional monetary policy, ECB, asset purchases, loss-absorbing buffer