Net stable funding ratio, interest rates and profitability: evidence from European banks

We investigate whether and to what extent the new Basel III liquidity standard, i.e., the Net Stable Funding Ratio (NSFR), affects banks’ profitability under a scenario of interest rates close to, or even below, the zero level. By reducing the asset-liability maturity mismatch, the NSFR might have a tremendous impact on banks’ ability to make profits. We argue that the joint effect of the adoption of ultra-expansionary measures of monetary policy and the new liquidity requirement can seriously threaten banks’ profitability. Based on a panel dataset of European banks observed over the years 2011-2018, we show that the relationship between NSFR and banks’ NIM and overall profitability is affected by the level and the trend of interest rates. The impact of the NSFR on banks’ NIM and overall profitability is positive during the years 2011-2012, when market rates firstly raise and then decline, showing a certain volatility. The decrease in the funding cost due to a better liquidity position and a lower exposure to funding liquidity risk is able to more than offset the drawback of lower interest earnings. This result does not hold for the years 2013-2018, when interest rates stay close to the zero level and, finally, become negative, but with a much more stable trend than the previous years. Furthermore, we argue that the higher level of interest rates in the years 2011-2012 gives banks the room to negotiate more convenient conditions with the clientele following the changes in market rates observed durinig those years. The proximity to the zero level of the interest rates and their stability remove or significantly limit that possibility