Projecting Banks’ Net Interest Income: an Asset-Liability Approach, Applied to the Euro Area

In a context of volatile interest rates, the impact of monetary policy decisions on banks’ net interest income is a key question for financial stability, since changes in profitability may affect their capacity to absorb losses and to accumulate capital through retained earnings. This paper presents an ALM-like model developed to project the evolution of the aggregate balance sheet and the interest income and expense of a banking sector under various scenarios. Based on balance sheet structure data, the model simulates the expiration of maturing instruments and the progressive accumulation of new issuances. Using conservation laws valid at the aggregate level, the model provides a consistent accounting-based framework, where bank reserve holdings depend on central bank actions, and the volume of customer deposits results from net payments between the banking sector and the rest of the economy. A combination of financial data sources makes it possible to build a simplified balance sheet of the aggregate euro area banking sector, on which the model can be run. Its total net interest income turns out to be, on the whole, positively sensitive to changes in interest rates. The model can also quantify sensitivities to other factors, such as central bank operations on securities or changes in the cost structure of customer deposits. Back-testing results on 2016–23 confirm the model’s ability to account for observed interest margins.