Risk Practice

How banks can ease

the pain of negative
interest rates
With better governance and data collection, treasurers can staunch
the effects of margin erosion.

by Andreas Bohn, Olivier Plantefeve, Thomas Poppensieker, and Sebastian Schneider

© by wildestanimal/Getty Images

February 2020
 By significantly reducing interest rates, central The impact on banks of negative-interest-rate
banks in Europe, Japan, and the United States have policies varies according to the bank’s business
sought to stimulate economic activity, stabilize model. Smaller banks focused on domestic loans
banking systems suffering from nonperforming and deposits are often hurt more than larger
loans, and manage exchange rates. A few have banks, which tend to be more diversified across
even pushed reference rates toward zero and below, currencies and have a larger share of fee business.
while also undertaking quantitative easing in the Banks of all sizes should prepare for the long-term
form of bond-buying programs, to push down term effects of negative interest rates and quantitative
rates as well. Against this background, central banks easing by adopting a comprehensive program of
are contemplating broader and more intensive countermeasures. Treasurers will be instrumental in
implementation of negative rates in case of a designing and implementing these measures.
severe downturn.

While economies have benefited, low and negative The components of

interest rates come with strong side effects for net-interest margins
investors and financial institutions. Over time, The main components of net-interest margins
negative interest rates hurt profitability by eroding are structural elements, margins on assets, and
banks’ net-interest margins. Japanese banks, for margins on liabilities (which depend on the
example, first saw net-interest margins increase as business model and regional setup) (Exhibit 2). The
client rates on deposits were reduced faster than structural elements include benefits from maturity
average rates on loans.¹ Soon thereafter, however, transformation, modeling and hedging the repricing
net-interest margins steadily declined as yields on tenor of the bank’s own funds, and liquidity buffer
loans and bonds acquired declined, pushed down income. They account for 15 to 35 percent of
by the Bank of Japan’s quantitative-easing program. net-interest margin and decline due to flattening
The increase in balance-sheet volumes did not interest-rate curves and tighter credit spreads for
offset the decline in net-interest margins. bonds. The other two components—the margins
on assets and liabilities—are more closely linked to
Economists and business analysts expect that the client business.
present squeeze on margins is going to last at least
five years, and probably more. Eurozone banks Negative interest rates and quantitative easing
could face a margin decline of eight basis points. create specific challenges for each component:
But there’s good news too: treasurers may be able
to mitigate most or all of the forecast depletion, 1. Structural elements: Banks have to hold
through a combination of effective governance, significant amounts of high-quality liquid assets
a clear risk-appetite framework for hedging to fulfill requirements set by the liquidity-coverage
strategies, and IT and data reporting that achieves ratio. These assets predominantly consist of
transaction-level transparency. central-bank reserves or government bonds that
mostly have negative yields.³ New regulatory
Since 2015, most banking sectors subject to requirements for term funding may extend the
negative-interest-rate policies have experienced a duration of liabilities requiring matching asset
decline in net-interest margins (Exhibit 1).² duration.⁴ Furthermore, a flattened yield curve

1
Christian Weistroffer, “Ultra-low interest rates: How Japanese banks have coped,” DB Research, Deutsche Bank, June 10, 2013, dbresearch.com.
2
The exception is Sweden, which has experienced healthy economic growth since 2014 with a robust mortgage market. Net-interest margins in the
banking sector increased in Sweden during this period, and at the end of 2019, the Riksbank decided to lift its key reference rate (seven-day repo
rate) back to zero (the rate for daily marginal deposits was set at –0.10 percent). See Qianying Chen, Mitsuru Katagiri, and Jay Surti, Banking in a
steady state of low growth and interest rates, International Monetary Fund working paper, Number 18/192, August 2018, imf.org; Kerstin Bernoth
and Alexander Haas, “Negative interest rates and the signalling channel,” European Parliament, Policy Department for Economic, Scientific and
Quality of Life Policies, Monetary Dialogue, September 2018, europarl.europa.eu.
³ The largest part of central-bank reserves receives negative interest rates although a minimum amount may be exempted. The tiering can be set as
a multiple of the minimum reserve requirements or discretionally for an individual bank. Many government bonds, the most suitable alternative to
central-bank cash, exhibit negative yields due to quantitative easing.
⁴ E xamples for regulatory term-funding requirements are the net stable funding ratio and the minimum requirements to issue eligible bail-in debt.

2 How banks can ease the pain of negative interest rates

Negative Interest Rates
Exhibit 1 of 5

Exhibit 1
Net-interest margins mainly declined in economies subject to negative-interest-rate policies.
Net-interest margins 2015–19, basis points

160

Eurozone –10
140

120

Sweden +1
100 Switzerland –7

80 Denmark –28

McKinsey 2020 Japan –22

60
Negative Interest Rates
Exhibit 2 of 5
2015 2017 2019

Source: European Banking Authority Risk Dashboard; SNL Financial

Exhibit 2
The three major components of net-interest margins are structural elements, margin on
assets, and margin on liabilities.
3 major components of net-interest margins, %
Breakdown of structural elements, %

Margin Own
on assets 40–60 funds 20–40

Structural Interest-
elements 15–35 rate risk 20–40

Margin on Liquidity
5–25 10–20
liabilities risk

Credit
10–20
risk

Source: Federal Financial Supervisory Authority (BaFin)—Deutsche Bundesbank

How banks can ease the pain of negative interest rates 3

 diminishes the benefits of maturity transformation. zero boundary is feasible to some degree, retail
Additionally, the stability of new deposits—and deposits are more difficult to reprice, because
hence their eligibility for maturity transformation— deposits would become inferior to cash holdings.
is uncertain. In addition, banks tend to experience significant
inflows of client deposits.⁷
2. Margin on assets: Banks accumulating excess
liquidity from deposits have a particular incentive Even if interest rates remain stable over the next
to increase lending to absorb this liquidity.⁵ five years, the impact of negative rates will continue
Some may increase their risk appetite for to squeeze net-interest margins, especially the
investments in securities and more risky loans, structural elements. Consequently, the net-interest
possibly compromising too much on the margin for margin for banks in the eurozone could decline
term loans.⁶ by another 8 basis points during this period. If the
interest-rate curve were to move down another
3. Margin on liabilities: The ability to reprice 50 basis points, the net-interest margin would drop
deposits faster than assets helps at the beginning. by a further 8 basis points—or more—depending on
While repricing corporate deposits below the the reaction of banks and clients (Exhibit 3).⁸

5
Selva Demiralp, Jens Eisenschmidt, and Thomas Vlassopoulos, Negative interest rates, excess liquidity and retail deposits: banks’ reaction to
McKinsey 2020 unconventional monetary policy in the euro area, European Central Bank working paper 2283, May 2019, ecb.europa.eu.
6
Florian Heider, Farzad Saidi, and Glenn Schepens, Life below zero: bank lending under negative policy rates, European Central Bank working
Negative Interest paper
Rates2173, August 2018, ecb.europa.eu.
Exhibit 3 of 5
7
Carlo Altavilla, Lorenzo Burlon, Mariassunta Giannetti, and Sarah Holton, Is there a zero lower bound? The effects of negative policy rates on
banks and firms, European Central Bank Working Paper 2289, June 2019, ecb.europa.eu.
8
For similar results, see “Results of the 2019 LSI stress test,” BaFin, September 23, 2019, bafin.de; see also “Sensitivity Analysis of IRRBB – stress
test 2017,” European Central Bank, February 28, 2017, bankingsupervision.europa.eu.

Exhibit 3
The projection for unmanaged development of net-interest margins over the next five years for
banks in the eurozone shows a decline of eight to 16 basis points.
Net-interest margins, basis points (bp)

160

150

2020–24 estimated
unmanaged
140 net-interest margins
assuming stable
rates –8

130
2020–24 estimated
unmanaged
net-interest margins
assuming +50 bp
120 rates –16

2015 2019 2024

Source: European Banking Authority Risk Dashboard; SNL Financial

4 How banks can ease the pain of negative interest rates

The treasurer’s role in Optimizing the risk–return profile of the
building resilience structural components of net-interest margins
Bank treasurers can play a central role in countering To optimize the risk–return profile of the structural
the impact of negative interest rates. They can do components of net-interest margins, banks need to
this by taking action in the following areas: identify formulate an effective governance model and a clear
and understand all relevant risks; implement risk-appetite framework for hedging strategies.
measures to shore up and stabilize the components These measures will allow the treasurer and related
of net-interest margins, including the structural and risk managers to make transparent, informative, and
client-related elements; and actively cooperate with effective proposals. The objective is to obtain clear
top management to help steer the business in the and timely decisions in the following areas:
negative-interest-rate environment.
— Behavioral models for nonmaturing deposit
Capturing risks balances feeding into interest-rate risk models
To identify and understand all relevant risks, and hedging strategies.
treasurers need reporting systems that capture, — Adjustments for mismatched maturity profiles of
model, and simulate interest-rate, funding, and assets and liabilities.
liquidity risks. The IT and data architecture
— Positions with positive convexity (financial
for reporting should create transaction-level
instruments which could disproportionally
transparency across legal entities. With these
benefit from further declines in interest rates
systems in place, treasurers can take these
and offset negative-convexity positions).
important actions:
— Assumptions regarding the interest-rate
— Choose a sufficiently long time horizon (such tenor of equity and respective replicating
as five years) for capturing the impact of hedge positions.
negative rates on net-interest margins and the — Assumptions on the size, composition, and
balance sheet. funding tenor of the liquidity buffer as well
— Assess the impact of political, legal, or as of collateral for payment and clearing and
reputational risks, such as the implied settlement systems.
zero percent floor for retail deposit and — Utilization of liquidity in foreign subsidiaries
mortgage rates. or branches, which can become trapped
— Review the dynamics of pension and insurance on local balance sheets due to legal or
risks due to changes in interest rates and the regulatory requirements.
interplay with inflation rates, credit spreads,
and longevity. Stabilizing client-related components
— Identify the characteristics of implicit and To stabilize the client-related components of
behavioral options, such as prepayment risk net-interest margins (assets and liabilities),
in loans and attrition risk in deposits, even if treasurers also need a funds-transfer pricing
they are not accounted at fair value. Quantify mechanism and limit system that does four things:
the risk arising from negative convexity in the provide business lines with incentives to generate
balance sheet positions (when bond prices interest-bearing assets, bring down funding costs,
move in the same direction as interest rates). increase the stability of deposits, and minimize
liquidity buffer requirements. Treasurers can
— When calculating scenario analysis
attain the leverage necessary to accomplish these
for the economic value of equity, also
objectives by taking certain measures:
consider the impact on commercial margins.
Perform reverse stress tests to identify
— Providing incentives to increase loan volumes in
critical moves in interest rates across
currencies with positive interest-rate levels.
different currencies.

How banks can ease the pain of negative interest rates 5

 — Encouraging new loan products and loan — Classifying hurdle rates for client deposits
products with digital distribution channels that as particularly stable from an internal-risk-
are scalable and can provide stable margins due management or regulatory perspective.
to fast processing and positive client experience. — Stimulating the shift of unstable deposits
— Linking mortgages and covered bond issuances with a zero interest-rate floor into alternative
more closely with respect to issuance volumes investment products.
and yields.
— Adjusting client rates for current accounts, These actions may include a temporary
short-term deposits, and savings deposits by increase in the loan-to-deposit ratio, reversing
McKinsey 2020 offering “account packages” with fixed fees. the traditional paradigm of targeting a low
Negative Interest—Rates
Introducing tiered pricing for larger deposit loan-to-deposit ratio. Denmark, Japan, Sweden,
Exhibit 4 of 5 balances and reference deposit rates to central- and Switzerland all took this approach from 2014 to
bank rates as appropriate for client group and 2018 (Exhibit 4).
purpose of deposits.

Exhibit 4
To stabilize the client-related components of net-interest margins (assets and liabilities),
Denmark, Japan, Sweden, and Switzerland temporarily increased loan-to-deposit ratios.
Net-customer-loan volumes, € billion Loan-to-deposit ratios, %

2014 2018 2014 2018

–5
percentage
Eurozone 13,819 +3% 14,269 Eurozone 124 119
points (pp)

Denmark –4% Denmark 261 +6 pp 267

650 625

Sweden +13% Sweden 181 +6 pp 187

596 675

Switzerland +38% Switzerland 86 +5 pp 91

1,016 1,406

Japan 4,217 +37% 5,777 Japan 50 +1 pp 51

Source: SNL Financial

6 How banks can ease the pain of negative interest rates

 Our experience and analysis suggest that treasurers and funding needs), legal entities, and strategic
may be able to mitigate most or all of the forecast planning. Modern technology in fact makes such
depletion of net-interest margins for the next five management overlays relatively easy to create.
years, through a combination of these mitigating Establishing organizational units that bridge
measures (Exhibit 5).⁹ The degree of mitigation will business lines and treasury departments can help
depend on a bank’s business model, its risk appetite, facilitate communication and implement measures.
its ability to employ more capital, and the degree
to which the specific levers discussed above have
already been deployed. The exact shape of the yield Ongoing strategic management
curve will also play a role. is needed
Simply stabilizing the net-interest margin will not
Steering the business sufficiently drive significant and sustainable income
To help senior leaders steer the businesses within growth. Banks need to take a strategic approach
the negative-interest-rate environment, treasurers to manage real growth. Treasurers can facilitate
must understand each business line’s specific that strategy by taking calculated steps in the
business model and criteria for success. To be following areas:
effective in their consultative capacity, treasurers
must help ensure that the roles and responsibilities — Expand off-balance sheet investment solutions,
among treasury, finance, risk, and the business lines such as deposit platforms, sweeps, fund
are clearly defined and universally understood. solutions, cash exchange-traded funds, and
The group needs to establish a shared view on insurance-based savings plans.
balance-sheet planning (including capital, liquidity,
McKinsey 2020
Negative Interest9 “2020:
Rates Europe rising—at the break of dawn,” Morgan Stanley, December 2019.

Exhibit 5 of 5

Exhibit 5
Treasurers can implement measures to mitigate projected depletion of net-interest margins.
Mitigating measures, basis points
8 2

144 2 144
3 Asset–liability
management
Structure
1 balance sheet

Reprice
Projected Optimize deposits
depletion, liquidity
2020–24 reserve

Net-interest Projected
margin, 2019 net-interest
margin, 2024

How banks can ease the pain of negative interest rates 7

 — Renew emphasis on fee- and commission- While today’s interest-rate environment poses
based products, such as payments, advisory enormous challenges to growth in the banking
business, and asset management. sector, many of the tools for addressing the
— Use incentives and capital allocation to expand challenges are well known to treasurers. By taking
loan volumes in high-margin businesses such as a more holistic approach to using these tools,
consumer finance and credit cards. bringing their own considerable expertise to
bear, and establishing a joint-management view
on strategic planning and balance sheet–capital
Treasurers can thus increase the efficiency of management, treasurers can play a vital role in their
their own oversight and bring valuable counsel to banks’ financial success in the next period.
the executive suite. Depending on the business
model, the regional setup of the bank, and the
deployment of additional capital, a comprehensive
program can improve net-interest margins by up
to 10 basis points. But timely and decisive action is
of essential importance.

Andreas Bohn is a partner in McKinsey’s Frankfurt office, Olivier Plantefeve is a partner in the Paris office, Thomas
Poppensieker is a senior partner in the Munich office, where Sebastian Schneider is a partner.

Copyright © 2020 McKinsey & Company. All rights reserved.

8 How banks can ease the pain of negative interest rates