How do 400 European Banks Portray the Effect of Risk on Profitability under Low Policy Interest Rates?
Alexandra Campmas  1@  
1 : Laboratoire d'analyse et de recherche en économie et finance internationales  (Larefi)  -  Site web
Université de Bordeaux (Bordeaux, France)
Université de Bordeaux, LAREFI (Bâtiment recherche économie) avenue Léon Duguit 33608 PESSAC Cedex -  France

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 bank risk has influenced profitability across the European banking sector from 1999 to 2015. Using a dynamic panel model, we clearly find that bank insolvency risk, proxied by the asymmetric Z-score and credit risk, captured by two financial ratios, have a negative impact on profits: the higher the risk, the lower the profit. This result is confirmed by the three measures of profitability we rely on: net interest margins and overall profitability, namely the Return on Assets and Return on Equity. 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.

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