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How do European banks portray the effect of policy interest rates and prudential behavior on profitability?

Alexandra Campmas

Research in International Business and Finance, 2020, vol. 51, issue C

Abstract: European policy interest rates have been low and trending downwards for almost a decade now and expectations do not seem to change. Hence, in such an environment, this paper investigates whether and how banks’ prudential behavior has influenced profitability across the European banking sector from 1999 to 2015. Using a dynamic panel model, we clearly find that banks’ financial resilience, proxied by the asymmetric Z-score and two financial ratios, affects profits: more cautious banks record higher profits. This result is confirmed by the two overall measures of profitability, namely the Return on Average Assets and Equity, but not for the Net Interest Margins. Furthermore, our analysis suggests that monetary policy's main instrument adversely affects bank income. Nevertheless, when policy interest rates are particularly low, the effect on Net Interest Margin is still positive, while the effect on the overall profitability becomes negative. These results induce that European banks succeed in increasing their profitability despite a compression of their net interest income.

Keywords: Profitability; Bank risk; Policy interest rate; Dynamic panel data models; European countries (search for similar items in EconPapers)
JEL-codes: C23 E5 G21 (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1016/j.ribaf.2018.09.001

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