How Lower Interest Rates Affect the Banking Sector

Abstract: With the further easing of inflationary pressures in the global economy, economic growth faces upward pressure. Domestically, broad government spending has slowed down and credit growth has been sluggish. The economy is facing pressure caused by low prices, employment difficulties, as well as low growth in residents' income and corporate earnings. Meanwhile, the lack of aggregate demand remains prominent, with broad government spending and real estate investment becoming the main drag. The meeting of the Political Bureau of the Communist Party of China (CPC) Central Committee and the statements by ministries and commissions have indicated a new countercyclical policy package, and next, implementation progress and strength would be most critical.

In response to the concern about lower interest rates will lead to a narrowing of spreads in the banking sector, the Feature part of this report first theoretically analyzes how lower interest rates affect banks and puts forward a preliminary analytical framework. Then it sorts out the impacts of large interest rate cuts on the banking system in developed countries and draws preliminary conclusions according to stylized facts. Finally, it reviews the performance of the banking system during the 2014-2015 interest rate cut cycle in China. On this basis, considering the characteristics of the Chinese banking system, the report discusses the possible impacts of the current sharp interest rate cuts on the banking sector and provides suggestions.