The impact of the interest rate level on bank profitability and balance sheet structure

Abstract

We study the sensitivity of bank profits and balance sheet structure to changes in the level of interest rates in Spain during the 2000-2016 period. Autoregressive distributed lag (ARDL) models with controls for the business cycle and interest rate levels are estimated for the time series of key asset and liability categories (credit, financial securities, time deposits, etc.) and profit components (returns on asset and liabilities, provision charges, etc.). We find a non-linear relation between interest rates and net interest income, which is positive at low interest rate levels. This relation is driven by the effect of interest rates on asset and liability returns, and also on credit growth, and on the bank mix of credit, deposits and financial securities. Broader profit measures also present a non-linear relation with interest rates, which can be negative even for low interest rate levels if provisioning charges are high enough.