Negative policy rates change the economics of banking in ways that can raise credit risk. Research by Claudio Borio of the Bank for International Settlements shows that prolonged negative rates compress net interest margins, the spread between lending and deposit rates, because banks have limited scope to pass negative returns onto retail depositors. This squeeze on core profitability can push banks toward riskier lending and business models to restore returns, increasing the probability of borrower default over time.
Mechanisms that raise borrower risk
When margins narrow, banks commonly respond with search for yield behavior: extending credit to lower-rated borrowers, lengthening loan maturities, or increasing exposure to cyclical sectors such as real estate. Benoît Cœuré of the European Central Bank has documented how incomplete pass-through of negative policy rates to retail depositors forces banks to rely more on fees or to take additional credit and market risk. These adjustments can dilute underwriting standards and concentrate exposures geographically or sectorally, elevating systemic credit vulnerability.
Consequences and territorial nuances
The consequences vary by banking model and region. In economies with large retail deposit bases and small commercial banks, such as parts of the euro area and Japan, negative rates have strained return-on-equity and encouraged mergers or business-model shifts. In territories where cash remains culturally important, the lower bound is less negative in practice because depositors can hoard cash, limiting central banks’ ability to push rates down further. Cheap borrowing can also feed asset-price inflation, notably in housing markets, creating later waves of mortgage delinquency if prices correct and local economies weaken.
Supervisory responses aim to limit the buildup of credit risk through intensified macroprudential oversight and limits on loan-to-value or debt-service ratios, measures emphasized by both BIS analysts and ECB officials. Nonetheless, if negative rates persist, the trade-off between supporting demand and preserving bank resilience becomes sharper. For policy makers and bank managers the central implication is clear: maintaining adequate capital and strict underwriting is essential to prevent short-term profitability pressures from becoming long-term credit losses.