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Analysis of the Relationship between Interest Rate and Bank Profitability (in Korean)

Author

Listed:
  • Jae-Joon Han

    (Division of Global Finance and Banking, College of Business Administration, Inha University)

  • Inhawn So

    (International Department, The Bank of Korea)

Abstract
This paper examines the impact of negative policy interest rate (NPIR) on bank profitability. In particular, we analyze the impact on its profitability after adding the gap cost to the Monti-Klein(1971)'s bank profit function which considers three important interest rates in the monetary policy transmission- interbank rate, deposit rate, and loan rate. As a result of the theoretical model analysis, in case of the loan amount exceeding the deposit amount in the low interest rate phase, the bank profitability improves as both deposit and loan rates fall under zero. However, this is in contradiction to the fact that European banks' profitabilities deteriorate due to NPIR. To resolve the contradiction, we also assumes the downward rigidity of deposit rate. If banks have the downward rigidity in deposit rates due to either the burden of securing deposits, which is the source of lending, or limitations on the expansion of the loan scale caused by the gap cost, its overall profitability may deteriorate. It is so because of both deteriorating profitability in deposits and limitation on the improvement of profitability in loan. In addition, we find that these deteriorating profitability are deepened as either the number of competing banks or the gap cost increases. Conversely, it should be noted that if the deposit rate is downwardly rigid under NPIR, it will not directly lead to the bank's profitability deterioration. However, as in the analysis of the paper, if the profitability of the bank deteriorates due to both limitations on the deposit rate adjustment and the increase in the loan under NPIR, negative interest rate policy(NIRP) should be conducted only in very exceptional circumstance.

Suggested Citation

  • Jae-Joon Han & Inhawn So, 2017. "Analysis of the Relationship between Interest Rate and Bank Profitability (in Korean)," Working Papers 2017-32, Economic Research Institute, Bank of Korea.
    • Handle: RePEc:bok:wpaper:1732
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    File URL: https://www.bok.or.kr/ucms/cmmn/file/fileDown.do?menuNo=600354&atchFileId=ENG_0000000001021224&fileSn=1
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    More about this item

    Keywords

    Negative Policy Interest Rate (NPIR); Banking Industry; Competition; Profitability; Downward Rigidity;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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