The Impact of Competition on Bank Risk Taking Under Negative Policy Rates

Abstract: We show that competition has a significant impact on the transmission of negative monetary policy rates via bank risk taking. By comparing stock returns for banks before and after the introduction of negative monetary policy rates, it is evident that high-deposit banks in highly competitive financial markets experienced the sharpest decline in net worth. Their inability to charge negative interest rates on deposits, together with high asset- and liability-side competition, put pressure on profitability, reduce net worth and increase risk taking. Therefore, high-deposit banks operating in highly competitive markets experience higher stock return volatility, higher CDS-spread returns and are also prone to invest in riskier asset classes when policy rates go below zero. A placebo test indicates that our findings indeed are a result of negative policy rates, as we see no effect when rates are non-negative. In addition to helping assess the long-term effects of negative monetary policy rates, our results might help further evaluate the well-studied trade-off between competition and financial stability.