Negative interest rates: incentive or hindrance for the banking system?

Overview & Synopsis

Since 2014, the ECB has applied a negative interest rate on the excess reserves (and deposit facilities) of commercial banks. This policy is complementary to Quantitative Easing (QE), a program whereby the ECB purchases securities on financial markets. Indeed, the QE provides liquidity to the banks and negative interest rates encourage them to reallocate this liquidity. The negative reserve rate amplifies the fall in short-term and long-term market rates and reinforces the incentive for commercial banks to operate reallocation on their portfolios towards riskier assets. The total amount of liquidity subject to a negative interest rate is 1047 billion euros. Negative interest rates should reduce interest rate margins but the impact on profitability is mitigated by the capital gains banks realise when selling securities to the ECB under QE, by the possibility banks have to finance themselves at negative rates, by a decrease in the risk of default and by the possibility to raise non-interest income.