The effects of negative interest rates: a literature review and additional evidence on the performance of the European banking sector

Reducing interest rates to below zero may be justified on theoretical grounds. However, in practice, it has been shown to create a number of distortions and malfunctions in several dimensions of banking system and the financial markets, which in turn may affect the whole economy. This paper surveys the theoretical grounds of unconventional monetary policy, focusing mostly on the available empirical evidence in order to provide a full picture of the impact of negative monetary policy rates. It also investigates the impact of negative interest rates on the European banking sector using a dataset of 3,155 banks from 36 European countries over the 2011–2018 period. Using a difference-in-differences methodology, we show that banks in negative interest rate environments experienced a 17.4% decrease in their net interest margins compared to banks operating in European countries that did not adopt negative interest rates. The results are found to be robust after combining propensity score matching with a difference-in-differences approach. Moreover, we find that banks that hold more liquid assets, that are highly capitalised, that have larger reserves at central banks and that take more customer deposits are more strongly affected by negative interest rates.