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Prolonged Low Interest Rates and Banking Stability

Author

Listed:
  • Kosuke Aoki

    (Professor, University of Tokyo (E-mail: kaoki@e.u-tokyo.ac.jp))

  • Ko Munakata

    (Associate Director, Research and Statistics Department, Bank of Japan (E-mail: kou.munakata@boj.or.jp))

  • Nao Sudo

    (Director, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: nao.sudou@boj.or.jp))

Abstract
Banks in developed countries share a common concern that prolonged low nominal interest rates may pose a threat to their business, as the level of nominal interest rates is often positively correlated with bank profits in the data. It is not well understood, however, how low nominal interest rates impact bank profits and what they imply for banking stability. To address these issues, this study theoretically explores how the level of nominal interest rates affects bank profits and banking stability in the long run by extending a model of bank runs constructed by Gertler and Kiyotaki (American Economic Review, 2015). The model, calibrated to Japan and other developed countries, makes three predictions: (1) low interest rates do indeed reduce bank profits by compressing the deposit spread; (2) due to the presence of the effective lower bound of the policy rate and a slow recovery of bank net worth after a run, low interest rates bring the economy closer to a state where a bank run equilibrium can exist; (3) although there are quantitative differences across countries, a decline in nominal interest rates does not necessarily bring the economy to a state with a bank run equilibrium on its own, except for in severe cases where the TFP growth rate or the target inflation rate falls below zero.

Suggested Citation

  • Kosuke Aoki & Ko Munakata & Nao Sudo, 2019. "Prolonged Low Interest Rates and Banking Stability," IMES Discussion Paper Series 19-E-21, Institute for Monetary and Economic Studies, Bank of Japan.
    • Handle: RePEc:ime:imedps:19-e-21
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    File URL: https://www.imes.boj.or.jp/research/papers/english/19-E-21.pdf
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    References listed on IDEAS

    as
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    Cited by:

    1. Daisuke Ikeda & Hidehiko Matsumoto, 2021. "Procyclical Leverage and Crisis Probability in a Macroeconomic Model of Bank Runs," IMES Discussion Paper Series 21-E-01, Institute for Monetary and Economic Studies, Bank of Japan.
    2. Shigenori Shiratsuka & Nao Sudo & Shingo Watanabe, 2019. "Central Bank Design under a Continued Low Inflation and Interest Rate Environment Summary of the 2019 BOJ-IMES Conference," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 37, pages 1-16, November.

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    More about this item

    Keywords

    Prolonged low interest rates; Bank profits; Banking stability;
    All these keywords.

    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • J11 - Labor and Demographic Economics - - Demographic Economics - - - Demographic Trends, Macroeconomic Effects, and Forecasts

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