## _wp16172

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---

### I. Introduction — context and recent adoption of NIRP
- Since the 1990s interest rates have been declining and remain low across all major advanced economies; low long-term interest rates reflect demographic changes, a slowdown in the rate of technological progress, and a high demand for safe assets relative to their supply (Bean and others, 2015).
- With short-term policy rates approaching zero percent, accommodative monetary policy faces difficulty reducing real interest rates to the “natural” rate consistent with stable inflation and output at potential.
- Historical constraint: central bankers long believed policy rates could not drop below zero because households and corporates might convert deposits into cash to avoid devaluation, conflating the nominal lower bound with the “physical lower bound.”
- Central banks that moved marginal policy rates into negative territory (selected effective policy rates as of end-July 2016):
  - Denmark: Deposit Facility -65 bps; Date of Introduction: July 2012-April 2014, Sept. 2014.
  - Euro Area: Deposit Facility -40 bps; Date of Introduction: June 11, 2014.
  - Hungary: Deposit Facility -5 bps; Date of Introduction: March 23, 2014.
  - Japan: Deposit Facility -10 bps; Date of Introduction: Feb. 16, 2016.
  - Norway: Deposit Facility -50 bps; Date of Introduction: Sept. 24, 2015 (noted as not true NIRP case).
  - Sweden: Deposit Facility -125 bps; Date of Introduction: Feb. 12, 2015.
  - Switzerland: Deposit Facility -75 bps; Date of Introduction: Jan. 15, 2015.
- Most central banks adopting NIRP also introduced a tiered deposit rate to reduce banks’ cost of holding excess reserves while maintaining pass-through to money markets.

### II. Theoretical effects and transmission under NIRP
- Purpose and macro effects
  - Negative rates remove the zero lower bound (ZLB) constraint, restoring signaling capacity and helping the real rate adjust downward when inflation and inflation expectations are low.
  - Moving marginal policy rate negative can significantly flatten the yield curve, allow inflation expectations to rise, and boost aggregate demand.
  - Countervailing risk: a widening gap between nominal and real rates could generate deflationary pressure.
- Exchange rate effects
  - Negative rates incentivize capital outflows to higher-yield jurisdictions, causing currency depreciation pressure via a widening real term spread differential.
  - Domestic demand and asset-price effects, or higher inflation abroad, can offset depreciation pressures.

### III. Economic lower bound and financial-intermediation constraints
- Direct costs and mitigation
  - Charging interest on excess central bank liquidity creates direct cost pressure and can prompt cash hoarding; central banks use tiered reserve regimes and penalties for large transfers to cash to limit this incentive.
- Indirect costs via bank profitability
  - As policy rates become more negative, the key economic lower bound is increasingly determined by diminishing bank profitability, since lending rates are assumed to fall more than deposit rates.
  - Retail deposit rates tend to be downward sticky because households and small businesses face lower setup costs for storing cash and because a zero percent interest rate can be a psychological threshold.
  - Stickiness can raise demand for cash, especially among agents with high excess liquidity and if negative rates are expected to persist.
- Implications for bank margins and funding structure
  - Net interest margins (NIMs) compress when lending rates on new and variable-rate loans decline while deposit rates remain sticky.
  - Banks may impose negative rates or fees on large deposits or substitute wholesale funding for deposits; substitution raises concerns about funding stability and access for smaller banks.
  - Prolonged negative rates could prompt banks to increase lending rates if constraints prevent corporate deposit rate cuts that would subsidize sticky retail deposit rates.
- Financial stability and supervision
  - Downward stickiness encourages substitution toward wholesale funding, requiring stronger supervision of liquidity and emphasis on LCR and NSFR implementation.
  - Countries with a wider deposit base (e.g., German, Italian, Portuguese, Spanish banks) may have greater incentives to shift funding structures.

### IV. Real economy and structural concerns
- Debt and resource allocation
  - Negative real lending rates can reduce debt-service burdens, potentially delaying exit of nonviable firms, adding to excess capacity, and delaying efficient allocation of capital and labor.
  - NIRP might delay corporate restructuring in economies with debt overhangs, particularly if inflation does not pick up; addressing resulting NPLs may require more assertive supervision and regulatory pressures.
- Social costs of cash substitution
  - Evidence (e.g., Danish experience) suggests consumers have strong cash preferences to avoid potential fees on electronic payments; imposing costs on electronic transactions led to a sharp drop in transactions in one case, indicating the socially acceptable deposit rate might not be far below the ZLB.

### V. Monetary transmission under NIRP — model scenarios (Box 1)
- Modeling approach
  - General equilibrium DSGE model adapted from Gerali and others (2010), estimated with euro area data.
  - Banking structure: banks have monopoly power in intermediation with distinct lending and deposit retail branches and a wholesale unit managing capital and wholesale funding subject to a solvency constraint.
  - Banks face different adjustment costs when changing rates; higher adjustment costs imply more stickiness.
- Scenarios (deposit rates bounded at zero and a policy cut occurs)
  - First case (blue line): unchanged pass-through — banks reduce both deposit and lending rates; bank profitability increases over time as output and inflation improve.
  - Second case (green dotted line): sticky deposits, solvency constraint non-binding — banks optimally lower lending rates to increase lending volume, profitability declines significantly as lending volumes are initially insufficient to offset margin compression.
  - Third case (red line): sticky deposits and binding solvency constraint — monetary transmission breaks down initially: banks increase lending rates and curtail credit growth given limited wholesale substitution; output impact remains positive but smaller initially.
- Key insight
  - Aggregate impact of NIRP is positive across scenarios, but sticky deposit rates combined with binding solvency constraints amplify pressures on bank profitability and can alter effectiveness of monetary transmission.
- Simulation caveat
  - Simulations abstract from offsetting components of banks’ net operating income (e.g., capital gains from higher asset prices and lower provisioning costs).

### VI. Money market transmission, tiering, and direct costs
- Money market and tiering mechanics
  - In excess liquidity environments, money market rate will be at or just above the marginal policy rate at which excess reserves are remunerated/penalized.
  - Tiered central bank deposit rates have facilitated smooth transmission of the marginal policy rate to money markets by excluding portions of reserves from the marginal rate.
  - Factors keeping money market rate above deposit rate: (i) amount of excess liquidity and fraction exempted, (ii) spread between marginal and average policy rate for excess reserves, (iii) banks’ willingness/ability to lend excess liquidity (fragmentation).
- Euro-area balances and direct-cost calculation
  - Overnight deposits: €297 billion.
  - Current account balances: €613 billion.
  - Combined overnight deposits and current account balances: about €910 billion.
  - Minimum reserve requirement: €116 billion remitted at the MRO rate of 0 percent.
  - Excess reserves subject to the negative deposit rate (marginal policy rate of -0.4 percent): €794 billion.
  - Direct (annual) cost of negative rates without tiering for all euro area banks in aggregate: about €3.2 billion (and 0.1 percent of total consolidated assets).
  - A 10 basis point reduction in the deposit rate results in a direct cost of about €0.8 billion per year.
  - Example: Switzerland’s experience where the direct cost of NIRP did not exceed 0.03 percent of total assets.
- Tiering implications
  - A tiered reserve regime excluding 75 percent of excess reserves from the negative deposit rate (in line with Switzerland) could theoretically allow further cuts to the deposit rate for the Eurosystem based on direct cost considerations alone.
  - Direct costs are unevenly distributed: banks in countries with large excess reserves bear greater charges because the ECB charges interest only on excess liquidity.
- Indirect effects
  - Indirect effect via lower bank profitability from lending is large: with total outstanding loans of about €17.6 trillion (end-May 2016) indirect effects through lending margins and provisioning can materially affect banks.

### VII. Empirical evidence on pass-through, lending, and profitability
- Aggregate net interest income baseline
  - If policy moved to -0.8 percent, euro area banks would record aggregate net interest income of about €141 billion (gross of operating expenses, provisioning, and taxes).
- Example impact of a small rate cut
  - With a 50 percent pass-through, a 10 basis point rate cut would reduce lending margins by 5 basis points and result in an indirect cost of about €8.8 billion (or 11 times the estimated direct cost of NIRP).
- Observed effects and heterogeneity
  - Negative deposit facility rate has been effectively transmitted through domestic credit channel; ECB’s Bank Lending Survey suggests negative rates increased household lending in the euro area.
  - Estimates show a small effect on aggregate NIMs: 7 basis points for a 50-basis point reduction in the policy rate.
  - Banks lowered lending rates to households and firms and offset negative impacts via small increases in fees/commissions and cost cutting.
  - In some countries (Denmark, Sweden) banks passed negative rates to large corporate/institutional deposits but maintained positive rates for retail depositors.
  - Many banks offset declining interest revenues with higher lending volumes, lower interest expenses, lower provisioning and capital gains; aggregate NIM improved slightly toward end-2015 after ~1.5 years of negative rates.
  - Transmission has become more heterogeneous across the euro area since NIRP adoption; higher pass-through where variable-rate loans are more prevalent.
- Limits and signs
  - Early evidence suggests adverse impact on bank profitability may increase non-linearly as policy rate declines further.
  - Return on assets for European banks is low at 0.24 percent (compared to 1.0 percent for U.S. banks).
  - Equity risk premia have risen and price-to-book ratios declined during the second half of 2015.

### VIII. Risks, distributional effects, and policy trade-offs
- Distributional impacts
  - Negative rates redistribute between savers (including elderly with accumulated savings) who are worse off and borrowers who benefit.
  - Higher asset prices increase net worth in present value terms and can support consumption and investment of liquidity-constrained agents.
- Non-linear risks and investor confidence
  - Prospect of prolonged low policy rates, structural bank challenges and large stocks of impaired assets worsen bank earnings outlook and could lead investors to revise down future earnings expectations.
- Policy trade-offs and recommendations
  - NIRP involves a trade-off between supporting aggregate demand and mitigating adverse effects on banks’ net interest margins and the bank lending channel.
  - Micro-level risks warrant balanced use of non-standard measures to mitigate risks to banks’ profitability and monetary transmission.
  - Further monetary accommodation could rely more on credit easing measures and a further expansion of the ECB’s balance sheet.
  - Focusing on asset purchases would raise asset valuations and aggregate demand while supporting the bank lending channel.
  - Further easing would benefit from more centralized fiscal policy support and structural reforms.

### IX. Appendix highlights — implementation and country experiences
- Tiering regimes and operational design
  - Tiering reduces the direct cost of negative rates by exempting a portion of reserves, allowing a lower marginal policy rate for the same direct costs to banks.
  - Classification: constant allocation (e.g., Norway, Switzerland) vs dynamic allocation (e.g., Sweden, Denmark, Japan).
  - The exemption threshold should be as high as possible to minimize average cost while still transmitting the marginal policy rate to money markets.
- Country vignettes (selected points)
  - Denmark: DN cut deposit rate to -0.75 percent in early 2015 to defend the peg; raised deposit rate to -0.65 percent in Jan. 2016; pass-through to depositors limited to large corporate customers.
  - Sweden: SR reduced reserve repo rate to -0.50 percent in Feb. 2016 and implemented asset purchases totaling SEK 245 billion by end-2016 (~37 percent of government bonds); retail deposit rates largely remained above ZLB.
  - Japan: introduced a three-tiered reserve system effective Feb. 16, 2016 with tier rates 0.1 percent, 0 percent, and -0.1 percent across different reserve categories.
  - Switzerland: SNB applied -0.75 percent to sight deposits above bank-specific exemption thresholds effective Jan. 22, 2015; some banks obtained wholesale funding at negative rates and placed raised funds with SNB at zero percent.
  - Hungary: MNB reduced the overnight deposit rate from 0.10 to -0.05 percent on March 23, 2016 and introduced targeted measures to support SME lending.
- TLTRO II mitigation (Box A3)
  - Recent ECB measures (monthly purchases of €80 billion and deposit rate -0.4 percent) are estimated to lower NIMs by 11 basis points on average (Germany: 5 bps; France: 4 bps; Italy: 11 bps; Spain: 13 bps).
  - Aggregate lending growth needed to offset NIM decline: 2.3 percent annually (up from 1.8 percent at end-January) for euro-area banks to maintain current profitability.
  - TLTRO II design: banks can borrow up to 30 percent of eligible non-mortgage private loans over four years with conditional liquidity at the marginal policy rate if net new lending exceeds at least 2.5 percent by Jan. 2018; unconditional liquidity at MRO rate otherwise.
  - Meeting TLTRO II requirements implies at least 1.2 percent annual lending growth over two years for banks with positive net lending in 2015; benchmark treatment differs for banks with negative prior lending.

*Source: IMF staff analysis contained in the provided content from _wp16172 - References*

### References .............................................................................................................

### _wp16172 - References

### I. Introduction — context and recent adoption of NIRP
- Since the 1990s interest rates have been declining and remain low across all major advanced economies; low long-term interest rates reflect demographic changes, a slowdown in the rate of technological progress, and a high demand for safe assets relative to their supply (Bean and others, 2015).
- With short-term policy rates approaching zero percent, accommodative monetary policy faces difficulty reducing real interest rates to the “natural” rate consistent with stable inflation and output at potential.
- Historical constraint: central bankers long believed policy rates could not drop below zero because households and corporates might convert deposits into cash to avoid devaluation, conflating the nominal lower bound with the “physical lower bound.”
- Central banks that moved marginal policy rates into negative territory:
  - Danmarks Nationalbank (DN): first cut below zero in July 2012 (negative until April 2014; turned negative again in September 2014).
  - European Central Bank (ECB): effectively moved marginal policy rate into negative territory in June 2014 to support price stability objective (below, but close to, two percent).
  - Sveriges Riksbank (SR) and Swiss National Bank (SNB): cut marginal policy rates below zero from mid-2014 to early 2015.
  - Norway (Sept. 2015), Japan (Feb. 2016), Hungary (March 2016): lowered only deposit rate for excess bank reserves while keeping main policy rate positive (noted as not true NIRP in some cases).
- Most central banks adopting NIRP also introduced a tiered deposit rate to reduce banks’ cost of holding excess reserves while maintaining pass-through to money markets.

### Table 1 — Overview of Central Banks with Negative Policy Rates (selected policy rates in basis points, effective as of end-July 2016)
- Denmark (Conventional peg to euro; Objective: Countering safe-haven inflows and exchange rate pressures)
  - Overnight Lending: 5
  - Open Market Operations: 0
  - Deposit Facility: -65
  - Date of Introduction: July 2012-April 2014, Sept. 2014
- Euro Area (Free floating, inflation-targeting framework; Objective: Price stability and anchoring inflation expectations)
  - Overnight Lending: 25
  - Open Market Operations: 0
  - Deposit Facility: -40
  - Date of Introduction: June 11, 2014
- Hungary (Floating, inflation-targeting framework; Objective: Price stability and countering exchange rate pressures)
  - Overnight Lending: 115
  - Open Market Operations: 90
  - Deposit Facility: -5
  - Date of Introduction: March 23, 2014
- Japan (Free floating, inflation-targeting framework; Objective: Price stability and anchoring inflation expectations)
  - Overnight Lending: 10
  - Open Market Operations: 0
  - Deposit Facility: -10
  - Date of Introduction: Feb. 16, 2016
- Norway (Free floating, inflation-targeting framework; Objective: Price stability — not a true NIRP case)
  - Overnight Lending: 150
  - Open Market Operations: 50
  - Deposit Facility: -50
  - Date of Introduction: Sept. 24, 2015
- Sweden (Free floating, inflation-targeting framework; Objective: Price stability and anchoring inflation expectations)
  - Overnight Lending: 25
  - Open Market Operations: -50
  - Deposit Facility: -125
  - Date of Introduction: Feb. 12, 2015
- Switzerland (Free floating; Objective: Reducing appreciation and deflationary pressures)
  - Overnight Lending: 50
  - Open Market Operations: n.a.
  - Deposit Facility: -75
  - Date of Introduction: Jan. 15, 2015
- Source note: effective policy rates are highlighted with a red background, as of end-July 2016; “Open Market Operations” column includes special rate (liquidity-shortage financing facility) for Switzerland. Norway and Hungary are not true NIRP cases for reasons described in the source.

### II. Arguments surrounding NIRP — theoretical effects and transmission
- Purpose and macro effects
  - Negative rates remove the zero lower bound (ZLB) constraint, restoring signaling capacity of the central bank and helping the real rate adjust downward when inflation and inflation expectations are low.
  - Moving the marginal policy rate into negative territory can contribute to a significant flattening of the yield curve and could allow inflation expectations to rise and boost aggregate demand.
  - Possible countervailing risk: if both nominal and real interest rates shift down but a widening gap occurs, deflationary pressure may result.
- Exchange rate effects
  - Negative rates provide incentives to move capital to higher-yield jurisdictions, causing currency depreciation pressure via a widening real term spread differential.
  - Higher inflation and inflation expectations abroad, or domestic demand and asset-price effects, can offset depreciation pressures.

### III. Economic lower bound and financial intermediation constraints
- Direct costs and mitigation
  - Charging interest on excess central bank liquidity creates direct cost pressure, potentially prompting cash hoarding; central banks have used tiered reserve regimes and penalties for large transfers to cash to limit this incentive.
- Indirect costs via bank profitability
  - As policy rates become more negative, the key economic lower bound is increasingly determined by diminishing bank profitability, since lending rates are assumed to fall more than deposit rates.
  - Retail deposit rates tend to be downward sticky because:
    - Households and small businesses face lower setup costs for storing cash compared to banks and corporations.
    - A zero percent interest rate can be a psychological threshold.
  - Stickiness can raise demand for cash, especially among agents with high excess liquidity and if negative rates are expected to persist.
- Implications for bank margins and funding structure
  - Net interest margins (NIMs) compress when lending rates on new and variable-rate loans decline while deposit rates remain sticky, reducing bank profitability and impairing pass-through to lending rates.
  - Banks may respond by imposing negative rates or fees on deposits (as seen on large deposits in several countries) or by substituting wholesale funding for deposits; substitution raises concerns:
    - Wholesale funding may be less stable.
    - Smaller banks may face limited market access.
    - Term premia and funding costs can limit the benefit of wholesale substitution.
  - A prolonged period of negative rates could prompt banks to increase lending rates if they face:
    - An opportunity cost of accepting deposits at non-negative rates while wholesale funding costs decline; or
    - Constraints preventing cuts to corporate deposit rates that would otherwise subsidize sticky retail deposit rates.
- Financial stability and supervision
  - Downward stickiness of deposit rates encourages substitution toward wholesale funding, requiring stronger supervision of bank liquidity and emphasis on LCR and NSFR implementation.
  - Countries with a wider deposit base (e.g., German, Italian, Portuguese, Spanish banks) may face greater incentives to shift funding structures.

### IV. Real economy and structural concerns
- Debt and resource allocation
  - Negative real lending rates can reduce debt-service burdens, potentially delaying exit of nonviable firms, adding to excess capacity, and delaying efficient allocation of capital and labor.
  - NIRP might delay corporate restructuring in economies with debt overhangs, particularly if inflation does not pick up.
  - Addressing resulting non-performing loans and debt overhangs may require more assertive supervision and regulatory pressures.
- Social costs of cash substitution
  - Empirical evidence (e.g., Danish experience) suggests consumers have strong cash preferences to avoid potential fees on electronic payments; imposing costs on electronic transactions led to a sharp drop in transactions in one case, indicating the socially acceptable deposit rate might not be far below the ZLB.

### V. Monetary transmission under NIRP — model scenarios (Box 1)
- Modeling approach
  - Uses a general equilibrium DSGE model adapted from Gerali and others (2010), estimated with euro area data.
  - Banking sector structure: banks have monopoly power in intermediation, with two retail branches (lending and deposit-taking) and a wholesale unit managing capital and wholesale funding subject to a solvency constraint.
  - Banks face different adjustment costs when changing rates; higher adjustment costs imply more stickiness.
- Scenarios presented (legend in source figure)
  - Blue line: unchanged pass-through scenario (first scenario, base case).
  - Green dotted line: sticky deposit scenario but non-binding solvency constraint for banks (second scenario).
  - Red line: sticky deposit scenario and binding solvency constraint for banks (third scenario).
- Key insight
  - Sticky deposit rates combined with a binding solvency constraint amplify pressures on bank profitability and can alter the effectiveness of monetary transmission under NIRP.

*Source: IMF staff and national central banks, content from _wp16172 - References*

### Box 1. Monetary Transmission under NIRP

### Box 1. Monetary Transmission under NIRP

### Scenarios of bank response under sticky deposit rates
- Three scenarios simulated assuming deposit rates are bounded at zero percent and a policy rate cut occurs:
  - First case (blue line): pass-through from the policy rate to deposit rate remains unchanged.
    - Banks reduce both deposit and lending rates.
    - Bank profitability increases over time as output and inflation outturns improve.
  - Second case (green dotted line): deposits are “sticky” due to higher adjustment costs in setting deposit rates.
    - Banks optimally lower lending rates to increase lending volume at the cost of deviating temporarily from the minimum capital requirement.
    - Bank profitability declines significantly as initial lending volumes are insufficient to offset compression of lending margins.
  - Third case (red line): same sticky-deposit environment but with strict enforcement of solvency constraints.
    - Monetary transmission breaks down initially: banks increase lending rates and curtail credit growth given limited substitution of wholesale funding (due to a large deposit base).
    - Impact on output remains positive but is smaller over the short term as wealth and substitution effects (from lower discount rates) push up loan demand, supporting consumption and investment.
- General simulation conclusion:
  - Positive aggregate impact of NIRP under all three scenarios.
  - Rising pressures on bank profitability over the short and medium terms if deposit rates have reached a lower bound and banks are capital-constrained.
- Note: simulations abstract from potentially offsetting components of banks’ net operating income (e.g., capital gains from higher asset prices and lower provisioning cost from higher debt service capacity of borrowers).

### Distributional and macroeconomic implications
- Distributional impacts:
  - Negative rates can increase the re-distributional impact of monetary policy on wealth and income: savers (including elderly with accumulated savings) are worse off while borrowers benefit.
  - Higher asset prices increase net worth in present value terms.
  - Lower borrowing rates support consumption and investment of liquidity constrained households and firms, potentially outweighing adverse impacts on savers.
- Channels that can compensate for adverse impacts of NIRP:
  - Stronger credit growth and/or higher non-interest income:
    - Credit supply effects from reduced profitability can be offset by credit demand effects if banks increase lending—this is more difficult if credit demand is low, assets re-price quickly, and bank competition is high.
    - Banks could supplement declining interest margins with fees and commissions.
  - Higher asset prices and lower funding costs:
    - Portfolio rebalancing with negative rates reduces term and credit risk premia, eases financial conditions, and supports credit creation and economic activity.
    - Decline in risk aversion increases asset prices and generates capital gains for banks.
    - Higher asset prices (especially with higher inflation) likely raise future income and strengthen borrowers’ repayment capacity, lowering expected provisioning costs and write-off charges for NPLs.
  - Stronger aggregate demand through portfolio rebalancing:
    - Negative rates increase household consumption and steer portfolios toward other investments, lowering firms’ general cost of capital via lower term premia on corporate bond yields.
    - Lower cost of capital makes more investment projects profitable, raising investment and credit demand.
    - Higher asset prices and lower interest expenses for indebted households (who tend to have higher marginal propensity to consume) boost household consumption through wealth effects.

### Money market transmission and tiering
- Money market behavior under NIRP:
  - Money market rates have closely followed an increasingly negative marginal policy rate without disruptions to market functioning.
  - In excess liquidity environments, observed money market rate will be at or just above the marginal policy rate at which excess reserves are remunerated (or penalized under NIRP).
  - In several countries, a tiered central bank deposit rate has facilitated smooth transmission of the marginal policy rate to money markets, reducing interbank lending costs and restoring signaling capacity of the central bank.
- Factors that can keep money market rate away from the deposit rate (technical floor of policy corridor):
  - (i) the amount of excess liquidity and the fraction exempted from the marginal policy rate,
  - (ii) the spread between the marginal and average policy rate for excess reserves,
  - (iii) banks’ willingness/ability to lend excess liquidity to each other (fragmentation).

### Tiering, direct cost of NIRP, and distribution across banks
- Euro-area balances and direct cost calculation (as presented):
  - Overnight deposits: €297 billion.
  - Current account balances: €613 billion.
  - Combined overnight deposits and current account balances: about €910 billion.
  - Minimum reserve requirement: €116 billion remitted at the MRO rate of 0 percent.
  - Excess reserves subject to the negative deposit rate (marginal policy rate of -0.4 percent): €794 billion.
  - Direct (annual) cost of negative rates without tiering for all euro area banks in aggregate: about €3.2 billion (and 0.1 percent of total consolidated assets).
  - A 10 basis point reduction in the deposit rate results in a direct cost of about €0.8 billion per year.
  - Example: Switzerland’s experience where the direct cost of NIRP did not exceed 0.03 percent of total assets.
- Tiering implications:
  - A tiered reserve regime excluding 75 percent of excess reserves from the negative deposit rate (in line with reserve system in Switzerland) could theoretically allow further cuts to the deposit rate for the Eurosystem based on direct cost considerations alone.
  - Direct cost of negative deposit rates affects banks disproportionately because the ECB charges interest only on excess liquidity; banks in countries with large excess reserves bear a greater charge.
- Indirect effects:
  - Indirect effect of NIRP via potentially lower bank profitability from lending can be large.
  - Given a total outstanding amount of loans of about €17.6 trillion (end-May 2016) at an average interest spread of [text truncated in source], indirect effects through lending margins and provisioning can materially affect banks.

*Prepared by Jiaqian (Jack) Chen and Andreas (Andy) Jobst. Source: IMF staff analysis contained in the provided content.*

### 0.8 percent, euro area banks would record aggregate net interest income of about €141 billion (gross of operating

### _wp16172 - 0.8 percent, euro area banks would record aggregate net interest income of about €141 billion (gross of operating expenses, provisioning, and taxes)

### Transmission mechanics and reserve tiering
- ECB operational configuration:
  - Marginal refinancing operations (MRO) rate: 0 percent.
  - Deposit facility rate: -0.4 percent.
  - Money market rate (EONIA) has converged to a volume-weighted average of (i) the deposit rate (at -0.4 percent) for excess reserves and (ii) the MRO rate (of 0 percent) for minimum reserves.
- Pass-through and tiering assumptions:
  - Historically conservative pass-through assumption: 50 percent.
  - Assumption of exempting 75 percent of reserves from a negative deposit rate was based on Switzerland where the share subject to negative deposit rates averaged 23 percent until end-2015.
  - Exemption of reserves can vary over time and would need to decrease as excess liquidity declines.
  - If exempted portion of excess reserves is too large, the money market rate could be higher than the lowest marginal policy rate because banks have little incentive to lend, creating scarcity and pushing up money market rates.
- Market liquidity sensitivity:
  - Average daily quoted turnover underpinning EONIA fixings has been about €12.6 billion (or 1.5 percent of excess liquidity) since January 2016, making the impact of the marginal policy rate on money market rates sensitive to changes in bank behavior and rate setting.
- Tiering effects:
  - A volume-weighted average of potentially two deposit rates—by excluding a certain share of reserves from the deposit rate and removing some excess liquidity from the interbank market—could marginally push up the money market rate toward the marginal policy rate.

### Direct and indirect costs to banks
- Aggregate net interest income baseline:
  - If policy moved to -0.8 percent, euro area banks would record aggregate net interest income of about €141 billion (gross of operating expenses, provisioning, and taxes).
- Example impact of a small rate cut:
  - Based on a 50 percent pass-through, a 10 basis point rate cut would reduce lending margins by 5 basis points and result in an indirect cost of about €8.8 billion (or 11 times the estimated direct cost of NIRP).
- Relative importance of lending vs. investments:
  - The aggregate balance sheet suggests lending is about 6-7 times more important than investments for profitability.
- Direct cost on excess reserves:
  - The direct cost imposed on excess bank reserves is modest relative to the size of the overall balance sheet because cash balances represent only a fraction of asset base; however, many banks earn negative returns on liquid assets required for liquidity risk management.
- Currency and cash hoarding:
  - Current levels of negative rates have shown no clear signs of cash hoarding in the euro area, Denmark, Sweden and Switzerland, although currency in circulation increases when interest rates decline.
  - In Switzerland, annual growth of currency in circulation is now higher than the pre-NIRP period (especially high-denomination banknotes) but still below earlier years (e.g., 2009 and 2012).

### Evidence on pass-through, lending, and profitability
- Lending transmission:
  - Negative deposit facility rate has been effectively transmitted through the domestic credit channel; ECB’s Bank Lending Survey suggests negative rates have led to an increase in household lending in the euro area.
  - Negative rates have strengthened portfolio rebalancing and enhanced the ECB’s forward guidance.
- Net interest margins (NIM) and lending spreads:
  - Estimates suggest a small effect on aggregate NIMs: 7 basis points for a 50-basis point reduction in the policy rate.
  - For selected euro area banks, lending spreads respond to reductions in the effective policy rate (VAR-based estimates for July 2006–May 2016).
- Observed bank behavior and profitability:
  - Banks lowered lending rates to households and firms and offset negative impacts on lending margins via some small increases in fees and commissions and cost cutting.
  - In some countries (Denmark and Sweden) banks passed negative rates to deposits of some large corporations and institutional investors but maintained positive rates for retail depositors.
  - In Switzerland, lending rates adjusted slowly when policy rates moved into negative territory, supporting bank profitability.
  - Many euro area banks have offset declining interest revenues with higher lending volumes, lower interest expenses, lower risk provisioning and capital gains; aggregate NIM improved slightly towards the end of 2015 after almost 1.5 years of negative rates.
  - Some banks (Sweden, Denmark, Switzerland) maintained overall profitability and benefited from historically low impairment charges and greater wholesale funding at negative rates.
- Limits and heterogeneity:
  - Monetary transmission has become more heterogeneous across the euro area since NIRP adoption, especially for household lending (higher pass-through where variable-rate loans are more prevalent).
  - If lending rates decline more than deposit rates and cash demand is highly elastic, deposit rate adjustment room is limited without compromising banks’ net interest earnings.
  - Banks might be reluctant to reduce lending rates unless they can substitute wholesale funding for more expensive deposit funding.

### Risks, nonlinearities, and distributional effects
- Non-linear adverse impacts:
  - Early evidence suggests adverse impact on bank profitability may increase non-linearly as the policy rate declines further.
  - ECB’s Bank Lending Survey shows banks’ profitability has recently declined and is expected to remain depressed.
- Investor confidence and capital effects:
  - Prospect of prolonged low policy rates, combined with structural bank challenges and large stocks of impaired assets, has worsened bank earnings outlook and could lead investors to revise down future earnings expectations.
  - Equity risk premia have risen and price-to-book ratios declined during the second half of 2015, with the average cost of equity now exceeding the return on equity.
  - Return on assets for European banks is low at 0.24 percent (compared to 1.0 percent for U.S. banks).
- Distributional concerns within euro area:
  - Direct cost of negative deposit rates is greater for banks in surplus countries where banks hold large excess reserves (e.g., Germany and the Netherlands) because the ECB charges interest only on excess liquidity.
  - Target 2 settlement of capital flows has generated uneven excess liquidity distribution across jurisdictions; Eurosystem asset purchases have further contributed to unevenness (e.g., France).
  - Tiering could mitigate direct costs and support transmission, but heterogeneity of national banking systems might complicate implementation.

### Policy implications and mitigating measures
- Tiered reserve remuneration:
  - Fine-tuning the exempted portion of excess reserves can alter effective transmission of negative rates to money markets.
  - Calibrating tiering so the opportunity cost of depositing with the ECB equals or exceeds expected net interest margin times the share of the deposit base funding loans can increase the incentive to lend.
  - Tiering has been used in countries (Japan, Switzerland) in conjunction with NIRP to reduce banks’ direct cost of holding excess reserves.
- Supportive programs and credit stimulus:
  - ECB’s TLTRO II could facilitate transmission to lending rates by mitigating adverse impacts of negative rates on banks’ lending margins; higher credit demand can offset declining margins and reinforce TLTRO II’s effect on bank profitability.
  - In the presence of large outstanding variable-rate loans and high asset impairments (e.g., Italy, Portugal, Spain), declining NIMs and weak credit growth amplify concerns about banks’ earnings capacity and ability to supply credit.
- Limits to enlarging asset purchase eligibility:
  - Moving deposit facility deeper into negative territory would make price-based exclusions for asset purchases less restrictive (more securities trading at negative yields would become eligible), but lowering the deposit rate would also cause yields to fall, leaving proportions of securities unchanged relative to the new rate.

*Source: _wp16172 (excerpts provided).*

### 3.  Change in Lending Spread and Net Interest

### 3.  Change in Lending Spread and Net Interest Margin (NIM)

### Change in lending spreads and NIM (coverage and measurement)
- Lending spread (housing) calculated for new agreements between June 2014 and Jan. 2016.
- Net interest margin (total) calculated for new agreements between June 2014 and March 2016.
- Lending spread is calculated as the difference between the lending rate for new business less the three-month money market rate.
- Sources: Bloomberg L.P., Haver, and IMF staff calculations.

### Relationship between NIM changes and nonperforming exposures (NPEs)
- Change of NIM measured between June 2014 and March 2016.
- Stock of NPEs measured as of end-June 2015.
- Sources: Bloomberg LP, EBA Transparency Exercise (2015) and IMF staff calculations.
- Observation from figures/text:
  - Current loan growth in selected economies is insufficient to offset the impact of declining margins.
  - Recent history suggests it is unlikely that credit will pick up under these conditions.

### Annual loan growth required to maintain NIM (end-2015)
- Required loan growth derived using the historical pass-through of policy rates and the elasticity of net interest margins to changes in term premia between Jan. 2010 and Feb. 2016; based on total mortgage and corporate loans at end-2015 to EA residents.
- Scenario assumption: assumes an increase of monthly asset purchases (until Sept. 2017) by the ECB and a reduction of the deposit rate by 10bps (as per ECB decision on March 10).
- Sources: Bloomberg L.P., EBA Transparency Exercise (2015), ECB, SNL, and IMF staff calculations.
- Comparison provided between:
  - Required loan growth (y/y percent change).
  - Current loan growth (y/y, March 2016).

### Deposits and interest rates on deposits (January 2016)
- Household and corporate deposits reported as percent of total liabilities (MFI = monetary financial institutions).
- Average interest rate on outstanding term deposits reported (both household and non-financial corporates).
- Sources: Bloomberg L.P., Haver, and IMF staff calculations.

### Euro Area average NIM and credit growth (asset-weighted)
- Time series shown for Loan Growth (y/y) - Households, Loan Growth (y/y) - NFC, and Net Interest Margin (rhs) covering years 2011–2016.
- Sources: Bloomberg, L.P.; ECB; and IMF staff calculations.

### Estimated sensitivity of loan and deposit rates to policy rate changes (2006–2016)
- Based on the cumulative response over three months to a one-percent reduction in the overnight money market rate (EONIA) using a VAR specification with a simple lag structure between July 2006 and May 2016.
- Volum e-weighted average based on lending to both non-financial corporates and households.
- Sensitivities reported for:
  - Existing loans ("back book")
  - Deposits
- Sources: Bloomberg L.P., Haver, and IMF staff calculations.

### Bank equity valuation, profitability, and credit supply
- Change in equity price and average net interest margin (NIM) measured between April 2015 and March 2016.
- Price-to-Book ratios and average monthly credit growth reported (weighted by bank assets) with series covering 2010–2016.
- Observations from figures/text:
  - Banks with weaker profitability experienced a larger decline in equity prices since 2015.
  - Low equity valuations raise the cost of equity.
  - The impact of lower returns on valuations has made banks less willing to lend, with credit supply lagging a recovery in bank equity.
  - The combined effect of low inflation and low expected profitability has depressed equity valuations of euro area banks, while U.S. banks have benefitted strongly from monetary easing, falling only recently as a result of broader market deterioration.
- Sources: Bloomberg, L.P.; and IMF staff calculations.

### Equivalency of government bond yield and marginal policy rate
- Time series (2011–2016) for “Equivalency of Government Bond Yield and Marginal Policy Rate (Years)” for euro area (core economies), Japan, and Switzerland.
- Note: the "equivalency line" shows the maturity term at which the prevailing government debt yield is no higher than the marginal policy rate in the respective jurisdiction.
- Source: Bloomberg LP and IMF staff calculations.

### Key quantitative items displayed in figures (as labeled)
- Chart time frames and measurement windows explicitly used in calculations:
  - Lending spread: June 2014 to Jan. 2016.
  - NIM: June 2014 to March 2016.
  - NPEs: end-June 2015.
  - Pass-through and elasticity estimation: Jan. 2010 to Feb. 2016.
  - Sensitivity VAR estimation: July 2006 to May 2016.
  - Scenario asset purchases: until Sept. 2017; deposit rate reduction by 10bps (ECB decision on March 10).
- Index base for equity/inflation/yield series: Index 2010 = Jan. 2010 for Euro Area and United States series.

### Conclusions and policy implications (from the chapter)
- Negative interest rates so far:
  - Have had a positive effect on the economy, helping to lower bank funding costs and boost asset prices.
  - Have significantly enhanced the signaling effect of the ECB’s monetary stance and strengthened its forward guidance.
  - Lowering the deposit rate has supported the portfolio rebalancing channel of the ECB’s asset purchase program by encouraging banks to substitute investment in riskier assets for excess reserves.
  - In some countries, rate cuts have been passed through to corporate and household borrowers, contributing to a modest credit expansion and bolstering the economic recovery.
  - Lower lending rates have encouraged higher credit demand as lending standards continue to ease.
- Concerns and limits:
  - Concerns about negative effects on bank profitability have for the most part not yet materialized, but further substantial reductions of the deposit rate will likely entail diminishing returns because the lending channel is crucially influenced by banks’ expected profitability.
  - Most banks have mitigated profitability squeezes with higher lending volumes, higher asset prices, lower funding costs, and possible cost savings from greater operational efficiency and consolidation, but there are limits to such mitigation measures.
  - The outlook for bank profitability has worsened recently, especially in euro area countries with a high share of variable rate loans and high dependence on deposit funding, where low credit growth amplifies concerns about sustainable bank profitability.
  - Additional rate cuts could weaken monetary transmission if lending rates fail to adjust or customers withdraw cash from banks; declining bank profitability could constrain credit expansion and undermine the aim of monetary easing.
- Policy trade-offs and recommendations:
  - NIRP involves a difficult trade-off between implementing unconventional policy measures to support aggregate demand and mitigating adverse effects of declining net interest margins on the bank lending channel.
  - The micro-level risks associated with negative interest rates warrant a balanced use of non-standard policy measures to help mitigate risks to banks’ profitability and its impact on monetary transmission.
  - Looking ahead, further monetary accommodation could rely more on credit easing measures and a further expansion of the ECB’s balance sheet.
  - Focusing on asset purchases would raise asset valuations and aggregate demand, while also supporting the bank lending channel.
  - Further easing would also benefit from more centralized fiscal policy support and structural reforms to support aggregate demand going forward.

*Source: IMF staff calculations and analysis as presented in the chapter "3.  Change in Lending Spread and Net Interest Margin (NIM)" of the provided IMF document.*

### Appendix I. Implementation Issues under NIRP

### Appendix I. Implementation Issues under NIRP

### Overview of Central Banks with Negative Policy Rates
- Bosnia and Herzegovina (two tiers)  
  - Objective: Transmission of the ECB’s monetary policy stance; also aimed at avoiding potential losses to the central bank  
  - Instrument/Rate: Deposit rate -0.20% (July 1, 2016)  
  - Note: 50% of the ECB’s deposit facility
- Bulgaria (two tiers)  
  - Objective: Transmission of the ECB’s monetary policy stance; also aimed at avoiding potential losses to the central bank  
  - Instrument/Rate: Deposit rate -0.30% (January 4, 2016); -0.40% (March 16, 2016)  
  - Note: the same interest rate as the ECB’s deposit facility
- Denmark (two tiers)  
  - Objective: Countering safe-haven inflows and exchange rate pressures (continued FX interventions)  
  - Instrument/Rate: Certificates of deposit (CD) with a sequence of rates: -0.20% (July 2012); -0.10% (January 2013); +0.05% (April 2014); -0.05% (September 2014); -0.20% (January 19, 2015); -0.35% (January 22, 2015); -0.50% (January 29, 2015); -0.75% (February 5, 2015); -0.65% (January 8, 2016)
- Euro Area (no tiers)  
  - Objective: Price stability and anchoring inflation expectations (together with asset purchase program)  
  - Instrument/Rate: Deposit rate -0.10% (June 11, 2014); -0.20% (September 10, 2014); -0.30% (December 9, 2015); -0.40% (March 16, 2016)
- Hungary (no tiers)  
  - Objective: Price stability and countering exchange rate pressures (together with a small asset purchase program)  
  - Instrument/Rate: Deposit rate -0.05% (March 23, 2016)
- Japan (three tiers)  
  - Objective: Price stability and anchoring inflation expectations (together with asset purchase program)  
  - Instrument/Rate: Deposit rate -0.10% (February 16, 2016)
- Norway (two tiers)  
  - Objective: Price stability  
  - Instrument/Rate: Reserve rate -0.25% (September 24, 2015); -0.50% (March 17, 2016)
- Switzerland (two tiers)  
  - Objective: Reducing appreciation and deflationary pressures  
  - Instrument/Rate: Sight deposits at SNB (with an exemption threshold) -0.75% (January 15, 2015)
- Sweden (no tiers)  
  - Objective: Price stability and anchoring inflation expectations (together with asset purchase program)  
  - Instrument/Rate: Reverse repo rate -0.10% (February 12, 2015); -0.25% (March 18, 2015); -0.35% (July 2, 2015); -0.50% (February 11, 2016)

- Notes from table (preserve original qualifiers):  
  - The Bulgarian National Bank (Българската народна банка) and Norges Bank (NB) imposed a negative interest rate on banks’ excess reserves held in the central bank on January 4, 2016 and September 24, 2015, respectively.  
  - The central bank of Bosnia and Herzegovina (Centralna Banka Bosnei Hercegovine) introduced a fee for the banks’ surplus reserves (exceeding the obligatory reserve rate of 10 percent) equal to 50 percent of the ECB’s deposit rate on July 1, 2016.  
  - In the case of Bosnia and Bulgaria, given their currency board arrangements with the euro as exchange rate anchor, it was not intended as an active monetary policy measure but to transmit the ECB’s monetary policy stance while avoiding potential losses to the central bank from inaction.  
  - A loosely defined tiered reserve system also applies to the ECB, which remunerates overnight deposits in the current account at the MRO rate of 0 percent (as of March 16, 2016), effectively exempting about one-seventh of current reserves from the marginal policy rate.  
  - Norway has not adopted NIRP, and the negative interest rate on bank deposits at the central bank (“reserve rate”) has had little or no influence on market rates.  
  - In conjunction with the exit from the exchange rate ceiling (to the euro).  
  - The asset purchase program started with the purchase of SEK10 billion and was gradually increased to a cumulative total of SEK245 billion by end 2016 or about 37 percent of government bonds.

### Box A1. The Mechanics of Tiered Reserve Systems — Key Findings
- Conceptual points:  
  - Banks’ cost of holding central bank liabilities varies with the structure of reserves and their remuneration. Central banks use tiering regimes to distribute excess reserves widely, protect domestic retail depositors, and place costs on wholesale/foreign investors contributing to excess reserves.  
  - The ideal exemption threshold is determined by the amount of domestic retail funding banks have at the time of introduction (the level of deposits central banks want to protect).
- Operational differences across central banks:  
  - Excess reserves at the ECB, the Swiss National Bank (SNB), and Norges Bank (NB) are held as overnight deposits.  
  - Danmarks Nationalbank (DN) and Sveriges Riksbank (SR) use a combination of overnight fine-tuning operations and one-week term deposits to attract reserves and other central bank liabilities above required amounts (“liquidity surplus”).  
  - ECB: single (negative) rate for excess reserves despite being first to move significantly into negative territory.  
  - BoJ and SNB: put in place tiered reserve regimes for excess reserves to mitigate burdens on bank earnings, facilitate market transactions, and discourage higher holdings of physical currency.
- Effects of tiering:  
  - Tiered reserve regimes reduce the direct cost of negative rates on excess reserves by exempting a portion from the marginal policy rate, allowing a lower marginal policy rate for the same direct costs to banks.  
  - The cost of holding depends on excess reserve holdings in the tier with the lowest marginal policy rate.  
  - The exemption threshold should be as high as possible to minimize average cost while still transmitting the marginal policy rate to money markets.
- Classification of existing tiered regimes:  
  - Constant allocation (e.g., Norway and Switzerland): exemption threshold specific to each bank (fixed multiple of required reserves). Example: total exemption amount set to NOK 45 billion in Norway; NB targeted reserves in system at NOK 35 billion with an interval of plus/minus NOK 5 billion. As long as excess reserves are below this exemption threshold, the overnight rate (NOWA) remains close to the key policy rate.  
  - Dynamic allocation (e.g., Sweden, Denmark, Japan): fine-tuning operations determine share of excess reserves placed with central bank as more costly overnight deposits; Denmark converts excess current account deposits into certificates of deposit; Japan designs portion subject to negative rates to increase over time with the monetary base target.
- Additional operational notes and evidence:  
  - In Sweden, SR administers a de facto tiered regime: marginal policy rate is determined by market-maintaining repo facility; excess reserves accepted as overnight deposits at repo rate minus 10 bps or as certificates of deposit at repo rate minus 75 bps for one-week maturity.  
  - Negative interest rates create incentives to hold cash rather than reserves; in Denmark, Sweden, Switzerland cash in circulation has increased but growth rates remain within the range seen over the last decade.  
  - Norway: the reserve rate cut to negative was intended to maintain banks’ incentive to redistribute reserves; the reserve rate did not influence the overnight rate in the absence of excess reserves.

### Box A2. Low and Negative Interest Rates in Denmark and Sweden — Key Findings
- Motivation and timing:  
  - Denmark introduced negative interest rates in July 2012 (pegged to the euro) to deter speculative pressures on the peg amid sizeable capital inflows. Further cuts in 2015 followed the SNB leaving its currency ceiling and the ECB expanding its asset purchase program, prompting DN to cut the deposit rate by 70 bps over four weeks.  
  - Sweden adopted NIRP to raise inflation to the two percent target and prevent a de-anchoring of inflation expectations.
- Effects on banks’ margins and rates:  
  - Decline in bank interest margins under NIRP was contained by the high share of wholesale funding. Money market rates turned negative and banks’ assets repriced downwards quickly given the high share of variable rate loans (greater importance for household loans in Sweden).  
  - Lending rates declined; retail deposit rates did not drop below the ZLB. As a result, the interest spread between lending and deposit rates narrowed—a development beginning in Sweden as rates reached low levels in 2014 before turning negative in 2015.  
  - A relatively narrow deposit base with high reliance on non-deposit funding at 52 percent of total funding at end-2015 allowed banks to benefit from lower money market rates (below their cost of deposit funding), mitigating impact on net interest margins (NIMs), which remained positive in aggregate.
- Other mitigating factors:  
  - Denmark: fee income rose with mortgage refinancing increases and provisions declined with improved loan portfolio quality (DN, 2015). Lending growth remained subdued.  
  - Sweden: fee income increased with rising inflows to banks’ investment funds and expansion of corporate advisory services (Asterlind and others, 2015). Higher loan volumes helped compensate for lower rates.  
  - The compensatory effect of credit growth under NIRP increases the importance of prudent lending, especially to households.
- Empirical/graphical notes preserved from source:  
  - Sweden: Bank Interest Rates, New Agreements (In percent) — series include Lending rate (all accounts), Deposit rates (all accounts), Repo rate for 2005–2015.  
  - Denmark: Bank Interest Rates, New Agreements (In percent) — series include Lending rate (all accounts), Deposit rate (all accounts), Policy rate for 2005–2015; note: 3-month moving average.  
  - Change in Lending Spread and Net Interest Margin (NIM) — shows Lending Spread and Net Interest Margin (percentage points).  
  - Estimated Sensitivity of the Average Household Lending and Deposit Rates to a Change in the Interbank Rate, 2008-2015 (multiple) — series: Existing loans, Deposits (deposit rate less 3-month money market rate).
- Source and authorship note: Prepared by Rima A. Turk and Andreas (Andy) Jobst. For more detailed analysis, see Turk (forthcoming). Additional notes: Negative interest rates have not been fully passed through to bank deposit and lending rates to households; large deposits from firms and institutional investors are paying negative interest rates. During the first quarter of 2016, however, NIMs for Swedish banks have declined (Kuelpmann and others, 2016).

### Box A3. The Impact of NIRP on Bank Profitability and the Mitigating Impact of TLTRO II — Findings and Scenarios
- Overall impact on euro area banks:  
  - Recent ECB measures (monthly purchases of €80 billion, up from €60 billion, and reduction of the deposit rate to -0.4 percent, down from -0.3 percent) are estimated to lower the NIMs of euro area banks by 11 basis points on average (Germany: 5 bps; France: 4 bps; Italy: 11 bps; Spain: 13 bps).  
  - The decline of NIMs is greater in countries with a higher proportion of variable rate loans and a higher cost of risk (such as Italy and Spain).
- Loan growth needed to offset NIM decline:  
  - Aggregate lending growth in the euro area would need to increase to 2.3 percent annually (up from 1.8 percent at end-January) for banks to maintain current profitability over the amortization period of their current loan book.
- TLTRO II design and intended effects:  
  - Starting in June, banks can borrow up to 30 percent of eligible non-mortgage private loans over a four-year period at the prevailing MRO rate.  
  - Two components:  
    - (i) Conditional liquidity at the marginal policy rate (equivalent to the rate on the deposit facility prevailing at the time of the allotment) if banks exceed a benchmark for net new lending of at least 2.5 percent by January 2018.  
    - (ii) Unconditional liquidity at either the MRO rate of currently 0 percent if banks do not satisfy the lending benchmark or at a discount to the MRO rate if banks exceed the lower benchmark.  
  - The decrease of the interest rate for conditional liquidity is graduated linearly depending on the percentage by which the bank exceeds the lower benchmark (calculated similar to current TLTRO).
- Quantified mitigation and requirements:  
  - TLTRO II could mitigate the adverse impact of NIRP by realigning refinancing cost to the marginal policy rate if banks meet a defined minimum rate of net lending growth.  
  - Meeting requirements for TLTRO II funding at the marginal policy rate implies at least 1.2 percent annual lending growth over a two-year period for banks with positive net lending in 2015 but a continued decline in the eligible loan book for banks that have been de-leveraging.  
  - For banks with positive lending growth over the 12 months prior to January 2016, the benchmark is zero net lending. The benchmark is lowered by the decline in eligible net lending in the same period for banks that have seen negative lending.
- Empirical/graphical notes preserved from source:  
  - Euro Area: Loan Growth Required to Maintain Net Interest Margins in the Banking Sector — charts and country comparisons (ITA, ESP, FRA, DEU, EA) showing required loan growth (y/y percent change) vs current loan growth (y/y, March 2016). Note: assumes new lending is fully funded using TLTRO I funds at a weighted average borrowing rate of -20bps; based on historical pass-through between Jan. 2010 and Feb. 2016; scenario assumes an increase of monthly asset purchases (until Sept. 2017) by the ECB and a deposit rate cut of 10bps (as per ECB decision on March 10).  
  - TLTRO II benchmark illustrations for banks with positive and negative credit growth (timeline Jan-15 to Jan-18 and target date Jan-18) showing pay deposit rate (-0.4%), pay MRO (0%), and graduated linear adjustment of MRO rate with +2.5% benchmark.  
  - Change in net lending charts: Current net lending (Jan. 2016, y/y) and Required threshold for cheapest ECB funding (net lending growth required to qualify for TLTRO II borrowing at the ECB deposit rate (-0.4%)).  
  - Use of Funds from Past and Future TLTROs (Percent of Respondents): categories include Granting loans, Refinancing, Purchasing assets across TLTRO (2014), TLTRO (2015), TLTRO (2016) survey responses (re-scaled to unity for 2015 responses).

- Additional methodological notes from source:  
  - Calculations control for continued amortization, bad debt write-offs, and re-statements of asset recoveries in estimating sensitivity of existing loan stock to interest rate changes; calculations do not include effects of capital gains from higher asset prices due to combined effect of negative interest rates and a flattening yield curve.  
  - Past evidence suggests a high effectiveness of TLTRO in stimulating new lending. Failure to meet the benchmark under TLTRO II does not result in early repayment after two years (unlike TLTRO I). Banks report lending during the 12 months ending January 31, 2016 to determine borrowing capacity and lending performance against the benchmark by end of January 2018.

*Source: National central banks; boxes and analysis as presented in the Appendix I text.*

### Appendix II. Overview of Other Countries with NIRP

### _wp16172 - Appendix II. Overview of Other Countries with NIRP

### Denmark
- Negative rates adopted to counter large capital inflows speculating against the long-standing Danish peg to the euro.
- The Danmarks Nationalbank (DN) cut its key deposit rate four times between January and February 2015 to a record low -0.75 percent (from -0.05 percent) to defend its currency peg against the euro―and following the announcement of the ECB’s asset purchase program and the Swiss National Bank abandoning its exchange rate floor in mid-January 2015.
- In March 2015, the DN announced an increase in the current account limit to DKK 145 billion from DKK 37 billion, thereby increasing the amount of deposit that banks could keep at the central bank without being charged the deposit rate and softening impact on banks.
- In January 2016, Denmark raised the deposit rate to -0.65 percent.
- Ability to pass on negative interest rate to depositors was limited to large corporate customers.
- Denmark’s experience highlights:
  - Importance of activity-based fees, such as mortgage application fees.
  - Long-term strategy of encouraging a shift from deposits into wealth management products to cope with reduced lending margins under NIRP.

### Sweden
- Rate cuts in 2014 and earlier driven by persistently low inflation; core HICP inflation at 0.5 percent in 2013-14, compared with euro area rates of 1.3 and 0.9 percent in those years.
- A sharp decline in inflation expectations in late 2014 and early 2015 preceded the shift to negative rates and domestic QE in February 2015.
- Measures followed the announcement of the ECB’s QE program in mid-January, which increased potential for appreciation pressures on the Swedish krona, reinforcing the need for strong policy action by the Swedish Riksbank (SR).
- In February 2016, the SR reduced the reserve repo rate by another 0.25 percentage points to the current level of -0.50 percent, in combination with its own asset purchase program of government debt securities in the cumulative amount of SEK 245 billion, which amounts to more than 35 percent of the market.
- Note: as opposed to other countries, the current deposit rate of -1.25 percent is not the effective policy rate (and only affects a small part of bank reserves in the context of fine-tuning operations).

### Japan
- On January 29, 2016, the Bank of Japan introduced a three-tiered reserve deposit system (effective on February 16) with a negative interest rate on marginal excess reserves.
- Tier details:
  - First tier: remunerated at 0.1 percent, applies to the average outstanding balance each financial institution held during benchmark reserve maintenance periods from January 2015 to December 2015 (approx. ¥210 trillion).
  - Second tier: remunerated at 0 percent, is the macro add-on balance, including required reserves and the reserves equivalent to the amount of the various lending programs (¥40 trillion). An additional portion will be added to this second tier over time in line with the monetary base target.
  - Third tier: remunerated at -0.1 percent, is the policy rate balance, that is, the residual reserve deposit, which is where additional reserves created by QE will initially go until the second tier is adjusted (currently ¥80 trillion/year).
- The amount in the third tier is expected to remain in the range of ¥10-30 trillion.
- To prevent financial institutions from increasing cash holding significantly, any increase in cash holding are deducted from the zero interest rate tiers of current account balance.

### Switzerland
- On December 18, 2014, the Swiss National Bank (SNB) announced negative interest rates on Swiss franc-denominated sight deposits above a pre-defined threshold which took effect on January 22, 2015.
- For domestic banks, the threshold was set to 20 times a bank’s required reserves as of the reporting period ending November 19, 2014 minus (plus) any increase (decrease) in cash held.
- The SNB does not charge banks with negative interest rates on their cash deposits below this threshold.
- Some Swiss banks benefitted from being able to obtain wholesale funding at negative rates and place the funds raised with the SNB at zero percent, realizing additional net interest income.1
- Switzerland exited its exchange rate floor vis-à-vis the euro at the same time as it announced a further cut of the central bank deposit rate from -0.25 to -0.75 percent (effective January 22, 2015) less than a month after it announced the cut in the policy rate from 0 to -0.25 percent.
- Following the announcement, activity in the interbank repo market increased as banks with unused exemption amounts had an incentive to trade with banks subject to negative interest on their excess reserves, distributing liquidity as efficiently as possible within the system.
- Footnote included in source:
  - 1 However, it was not possible for all banks to realize such arbitrage gains, as the aggregate amount of excess reserves in the banking system exceeded the exemption threshold upon introduction of the negative rate.

### Hungary
- Given subdued inflation pressures and a structural liquidity surplus, the Hungarian National Bank (Magyar Nemzeti Bank, MNB) gradually eased its monetary policy stance and introduced unconventional instruments over the last two years.
- Objective: strengthen the interest, credit, and expectation channels, and lessen vulnerabilities.
- Conventional measures included:
  - Gradual reduction of the policy rate.
  - Lowering and narrowing of the interest rate corridor.
  - An effective reduction of reserve requirements.
  - Changing the collateral requirements for the MNB’s lending facilities.
- Effective March 23, 2016, the MNB reduced the policy rate and reduced the overnight deposit rate from 0.10 to -0.05 percent.
- Unconventional measures introduced:
  - Supporting SME lending by providing cheap MNB funding for banks to on-lend to SMEs and offering incentives to banks (through interest rate swaps and a special deposit facility) to increase their lending to SMEs.
  - Incentivizing banks to substitute government securities (especially long-term and local currency-denominated) for excess reserves with the MNB.

*Source: Appendix II. Overview of Other Countries with NIRP (content unit)._wp16172*

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