Negative interest rate policies (NIRP) reduce bank profitability primarily by compressing net interest margin, the difference between interest earned on loans and interest paid on deposits. Central banks in several jurisdictions have set policy rates below zero to stimulate demand; banks face a deposit rate floor because retail customers resist negative balances. This asymmetry means banks cannot fully pass negative policy rates to depositors while asset returns fall, squeezing margins. Claudio Borio at the Bank for International Settlements has emphasized that this margin compression is a key channel through which unconventional monetary policy alters banking-sector incentives.
How margins and behaviour change
The immediate effect is a tendency for lower lending spreads and reduced interest income. Banks with a heavy reliance on retail deposits and traditional lending suffer more, while those earning sizable fee income or holding flexible funding sources can cushion the impact. Ulrich Bindseil at the European Central Bank has written about central-bank operational responses such as tiering, which exempts part of banks’ reserves from negative rates and thus mitigates pass-through to banks’ profitability. At the same time, evidence discussed in BIS research shows that sustained low-for-long rates encourage a search for yield: banks shift into longer-duration assets or riskier credit to preserve returns, which can raise systemic risk over time.
Consequences for structure and stability
Lower profitability has several consequences. Persistently compressed earnings reduce banks’ ability to absorb losses, potentially slowing credit growth if capital constraints tighten. Small regional banks and community lenders in economies with high deposit funding are often the most exposed, contributing to pressure for consolidation or business-model change. Policymakers balance these trade-offs: the contractionary effect on bank margins is weighed against macroeconomic benefits of lower rates. BIS researchers including Claudio Borio warn that extended reliance on negative rates can promote risk-taking and reduce market discipline, while ECB analysis by Ulrich Bindseil and staff shows that design choices such as rate tiering and central-bank asset purchases materially alter the distributional impact across institutions.
Overall, NIRP tends to reduce headline bank profitability but with important cross-country and cross-bank variation. The policy’s net effect depends on institutional features, bank business models, regulatory buffers, and how long negative rates persist—factors that shape the economic, territorial, and social implications of prolonged negative-rate environments.