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The tipping point: interest rates and financial stability

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  • Porcellacchia, Davide

Abstract

This paper studies how interest rates impact bank stability in a standard banking model. There are two opposite effects. While higher rates widen banks’ interest margins, they also reduce the value of their long-term assets. First, the paper characterizes conditions under which an effect dominates. Second, it shows that banking crises are triggered by interest rates crossing a tipping point. Quantitatively, I find that the effect on interest margins is dominant. Hence, low rates are the threat to bank stability. Moreover, I estimate the tipping point at 0.32% for the US economy in the decade before the Global Financial Crisis. JEL Classification: E43, E50, G21

Suggested Citation

  • Porcellacchia, Davide, 2020. "The tipping point: interest rates and financial stability," Working Paper Series 2447, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20202447
    Note: 3169100
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    References listed on IDEAS

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    Cited by:

    1. Heider, Florian & Leonello, Agnese, 2021. "Monetary Policy in a Low Interest Rate Environment: Reversal Rate and Risk-Taking," Working Paper Series 2593, European Central Bank.
    2. Wang, Olivier, 2020. "Banks, low interest rates, and monetary policy transmission," Working Paper Series 2492, European Central Bank.
    3. Porcellacchia, Davide & Sheedy, Kevin D., 2024. "The macroeconomics of liquidity in financial intermediation," Working Paper Series 2939, European Central Bank.
    4. Porcellacchia, Davide, 2021. "Low rates and bank stability: the risk of a tipping point," Research Bulletin, European Central Bank, vol. 88.

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    More about this item

    Keywords

    deposit franchise; effective lower bound; financial crisis; maturity mismatch;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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