expected to have large effects on bank profitability if banks depend primarily on wholesale funding, large depositors, and foreign depositors. Banks that rely primarily on retail deposits, which exhibit limited interest rate pass through from NIRP would likely suffer larger margin compression than banks that rely mainly on wholesale funding. The fact that interbank market rates have moved deeper into negative territory than retail deposit rates, as documented earlier, highlights this differentiated impact. The effect of NIRP on bank profitability also depends on banks’ ability to diversify income sources and raise bank fees.

The euro area Bank Lending Survey of April 2016, found that there is a perception among banks that NIRP has already hurt or is expected to hurt profitability (Figure 11). For instance, more than 80 percent of banks participating in the survey stated that the negative deposit facility rate contributed to a decrease in their net interest income (ECB 2016b). According to the survey, the asset purchase programs of the ECB also reduced net interest margins and profitability of banks, despite improving capital gains. The decline in euro area bank equity prices since mid-2015 could partially be ascribed to market concerns about future profitability.

However, bank profitability depends more fundamentally on the overall health of the economy, affecting both the volume of lending and its quality.<sup>22</sup> Stronger growth should help reduce nonperforming loans, reinforce banks’ capital base and steepen the yield curve, which are all important factors supporting lending and profitability conditions (Shin 2016). Evidence suggests that net income of large euro area banks have not been significantly affected so far, thanks to lower impairments and higher non-interest income (ECB 2016c).<sup>23</sup> Across NIRP countries, bank lending margins remain within post crisis ranges, despite showing some signs of compression.

Recent empirical research documents an increase in loan growth upon the introduction of NIRP in the euro area. Rostagno et al (2016) show that under NIRP, euro area banks have become more likely to turn extra reserves into lending or bond purchases, and that total lending to companies has gone up relative to a counterfactual scenario. The ECB’s July 2016 Bank Lending Survey also indicates that loan supply conditions for both enterprises and households continued to improve during the first half of 2016 (ECB 2016d). Across NIRP economies, credit growth has generally improved, albeit sluggishly in most cases.

> 22 Beyond profitability, European banks appear to have been able to enhance somewhat their shock-absorbing capacity in recent years. According to the latest stress test results on 51 large European banks, 43 maintained a common equity tier 1 ratio above 8 percent in a severe recession scenario, showing improved resilience from similar tests in 2014 (EBA 2016). Having said that, concerns remain about euro area banks because of a large stock of legacy assets and non-performing loans (World Bank 2016b).

> 23 Draghi (2016) emphasized that the ECB had _“no evidence that [negative interest rates] hampered the transmission of monetary policy, and when we look at bank profitability, we see that 2015, the first full year with negative interest rates has not affected, or has not caused negative interest income, net interest income going down. As a matter of fact, it went up.”_ He also noted that _“Now, of course we've got to be cautious here because we talk about the aggregate of the banking system in the euro area, and of course aggregates may actually conceal different realities.”_ Cœuré (2015) argued _“...whether bank profitability really falls when policy rates are lowered depends more generally on the slope of the yield curve, on banks' investment policies and on factors driving non-interest income.”_

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