Simple Banking: Profitability and the Yield Curve

44 Pages Posted: 25 Mar 2014

Date Written: January 24, 2014

Abstract

How does bank profitability vary with interest rates? We present a model of a monopolistically competitive bank subject to repricing frictions, and test the model’s predictions using a unique panel data set on UK banks. We find evidence that large banks retain a residual exposure to interest rates, even after accounting for hedging activity operating through the trading book. In the long run, both level and slope of the yield curve contribute positively to profitability. In the short run, however, increases in market rates compress interest margins, consistent with the presence of non negligible loan pricing frictions.

Keywords: banking profitability, net interest margin, interest rates

JEL Classification: E4, G21

Suggested Citation

Alessandri, Piergiorgio and Nelson, Benjamin, Simple Banking: Profitability and the Yield Curve (January 24, 2014). Bank of Italy Temi di Discussione (Working Paper) No. 945, Available at SSRN: https://ssrn.com/abstract=2413438 or http://dx.doi.org/10.2139/ssrn.2413438

Piergiorgio Alessandri (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Benjamin Nelson

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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