The European Central Bank (ECB) Working Paper series offers in-depth analysis of critical issues affecting Europe’s banking sector. This paper by Olivier Wang explores the effects of low interest rates on the transmission of monetary policy and long-term bank lending.

The study indicates that as interest rates remain low, retail loan and deposit rates become less responsive to monetary changes, making it harder for banks to adjust. Over 20 years, the spread between US bank loan yields and Treasury bonds has nearly doubled despite stable risks and lower costs.

Key loan highlights include: banks can offer attractive terms during low-rate periods, but the ability to pass on policy changes to consumers may diminish. This environment potentially leads to higher spreads on loans, affecting overall lending supply.

Interest Rate Study: Steps to Understand Impact

• Review average loan and deposit rates for the last twenty years.
• Compare the responsiveness of these rates to shifts in central bank policies.
• Assess loan supply changes and credit growth trends.

Pros: Loan Market Advantages

Banks can still boost loan supply following rate cuts, supporting economic growth in the short run. Lower rates can be beneficial for borrowers by reducing funding costs on new loans.

Cons: Challenges in a Low-Rate Environment

However, as rates persist at low levels, bank profitability from both loan and deposit spreads contracts. This can lead to a tighter supply of credit and higher borrowing costs over time, impacting long-term investment.

Our Verdict

The ECB Working Paper provides important insights for borrowers and policymakers. While lower interest rates may initially stimulate lending, they pose long-term challenges to bank profits and credit availability. For those considering new loans or investment strategies, staying informed about rate environments and how banks adapt is crucial.