The Effects of Negative Interest Rates on Interbank Markets

We show that the effects of negative interest rates are amplified in the unsecured interbank market. As retail deposit rates are floored at zero while asset returns track policy rates, the use of deposit funding shrinks net returns, lowers bank capital and raises the cost of external financing. We find that deposit reliant banks face stronger downward pressure on net interest margins and are more likely to reduce lending to the same borrowing bank in the interbank market. However, deposit funded banks also tend to be more profitable and better capitalized to begin with, partially alleviating the adverse impact of negative rates.