Comprehensive monetary policy frameworks classification goes global

Prof David Cobham of Heriot-Watt University has built a database of evolution of monetary olicy frameworks of 179 countries over 1974-2017: https://monetaryframeworks.org/.

Cobham explains the database and methodolgy in theis voxeu post:

Monetary policy frameworks have evolved significantly around the world over the past four decades. This column introduces an updated, freely available, database of monetary policy frameworks, which now covers 179 countries/currency areas over the period 1974-2017. The classification covers both domestic and external monetary policy targets and both de jure and de facto targets. It makes possible for the first time a clear and detailed examination of the worldwide and regional trends in monetary policy frameworks since the Bretton Woods era, and provides a resource that can be used in a wide variety of research settings.

Historical monetary and financial statistics for policymakers: towards a unified framework

Claudio Borio, Øyvind Eitrheim, Marc Flandreau, Clemens Jobst, Jan F Qvigstad and Ryland Thomas in this BIS paper stress on the importance of Historical monetary and financial statistics:

In recent years, many central banks have engaged in data projects aimed at the collection and documentation of historical monetary and financial statistics (HMFS) for their respective countries. Long runs of data for key macroeconomic time series are increasingly being used in policy-oriented research. Information from these historical databases is used to draw parallels between current developments and historical events to shed light on today’s policy issues in the areas of monetary and financial stability.

The aim of the Bank for International Settlements (BIS) HMFS project is to establish a network between interested central banks that have already invested in local national HMFS databases, using the BIS as a hub. This BIS paper is an attempt to take stock of what counts as “good practice” in collating HMFS and how it should be implemented in different contexts.

Commodity Price Shocks and Non-Performing Assets in the Indian Banking Sector

Abhishek Kumar, Rakesh Mohan & Divya Srinivasan of Centre for Social and Economic Progress (CSEP) in this working paper show correlation between bank npas and global commodity prices.

Non-performing assets in the Indian banking sector increased significantly in the 2010s, accompanied by a slowdown in credit and GDP growth rates. In this paper, we show that nonperforming assets in the banking sector and profit ratios in commodity-sensitive non-financial
sectors are highly correlated with global commodity prices.

To estimate the effect of movement in commodity prices on non-performing assets, we create nominal price and inflation exposure indices for banks using novel data on banks’ sectoral exposure and commodity prices. These measures capture banks’ exposure to commodity prices through their borrowers’ profitability and cash flow and act as income shocks for banks. Results from a range of models suggest that a 1% decline in nominal exposure increases non-performing assets by 0.20-1.35% and these models explain ~30% of the increase in non-performing assets.

Since public sector banks in general had higher exposure to commodity-sensitive sectors, they experienced a relatively higher decline in nominal exposure and a more significant rise in non-performing assets after the price crash of the 2010s. The increase in non-performing assets is followed by a decrease in credit growth. These results help us in understanding the origins of India’s twin balance sheet crises of the 2010s.

Should RBI establish a forex swap line with Federal Reserve?

Should RBI establish a forex swap line with Federal Reserve? I explain in this moneycontrol article.

100 years of Central Bank of Lithuania

Central bank anniversaries are very useful to reflect on the past and think about the future.

Central Bank of Lithuania has completed 100 years in 2022.

The year 2022 marks the centenary of the establishment of the Bank of Lithuania, the central bank of the Republic of Lithuania. The Bank of Lithuania strengthens the stability of the country’s financial sector, actively acts as a centre of excellence in financial and economic issues, promotes competition in the payment services market and searches for new forms of supervision of financial institutions. As part of the Eurosystem, we cooperate with the European Central Bank and other euro area central banks to make decisions on the euro area monetary policy and its implementation.

Re-established on 1 March 1990, the Bank of Lithuania continues the traditions of the country’s central bank that operated during the interwar period. Plans to establish a bank of issue in Lithuania and to introduce national money began to be made immediately after the restoration of statehood in 1918, however due to the difficult financial situation of the State, the Bank of Lithuania commenced its activities only in 1922. The laws on the currency unit and on the Bank of Lithuania were passed on 9 and 11 August 1922 respectively, the Bank was officially established on 27 September 1922 and commenced its activities on 2 October. The founder of the Bank was the Government. The primary objective of the Bank of Lithuania was to regulate currency circulation, facilitate cash withdrawals, develop a sound and sustainable monetary system as well as foster the development of agriculture, industry and trade. The Bank was granted the right to issue banknotes for the period of 20 years, it could also carry out state treasury and saving bank operations, distribute and redeem the State’s loan sheets, provide commercial credit, etc. Vladas Jurgutis (1885-1966) became the first Governor of the Bank of Lithuania. The representative building of the Bank of Lithuania at the intersection of K. Donelaičio and Maironio streets in Kaunas was built 6 years after the Bank’s establishment, specifically to meet the needs of the central bank.

Today, the mission of the Bank of Lithuania is to bring benefit to society. To accomplish this mission, we have brought together highly qualified staff and the necessary financial and technological resources. We have a clear vision of what our organisation should be like in the near future. The work of our staff, anchored by the institution’s core values, not only brings benefit to society, but also contributes to enhancing the trust of the people of Lithuania in the national central bank and the domestic financial system as a whole. The Bank of Lithuania currently employs more than 600 members of staff and is headed by Gediminas Šimkus as of April 2021.

 

Need for Transparency in RBI’s Prompt Corrective Action Framework

The RBI recently took out the Central Bank of India from the Prompt Corrective Action Framework:

The performance of the Central Bank of India, currently under the Prompt Corrective Action Framework (PCAF) of RBI, was reviewed by the Board for Financial Supervision. It was noted that as per the assessed figures of the bank for the year ended March 31, 2022, the bank is not in the breach of the PCA parameters. The bank has provided a written commitment that it would comply with the norms of Minimum Regulatory Capital, Net NPA and Leverage ratio on an ongoing basis and has apprised the RBI of the structural and systemic improvements that it has put in place which would help the bank in continuing to meet these commitments.

Taking all the above into consideration, it has been decided that Central Bank of India is taken out of the PCA restrictions subject to certain conditions and continuous monitoring.

I had written earlier that RBI should be more transparent in reporting on pca framework. I had argued the regulaor should have kid of a dashboard which lists the banks in pcaf and the various metrics on which select banks are in and out of the list. Some critical information may not be shared but there is a need for more clarity on which banks are in and out of pca and the basis for the in and out of the list.

 

CBDCs: The Past, the Present and the Future

Payal Ghose and Abhishek Date of Clearing corporation of india summarise developments on CBDCs.

Digital currencies are the latest stage in the continual process of evolution in money since the transition from barter of goods. Finance Minister Nirmala Sitharaman while presenting the Union Budget 2022- 23, announced the introduction of Digital Rupee to be issued by the Reserve Bank of India (RBI) starting 2022-23 using blockchain and other technologies for cheaper and efficient currency management. On this backdrop, this article explores the evolution of Central Bank Digital Currencies (CBDCs) and their role in thefinancial landscape of thefuture.

What the RBI can do to contain the rupee’s depreciation

Actually rbi should not do much and allow rupee to depreciate.

My explainer in moneycontrol.

Rebel Governance and Development: The Persistent Effects of Guerrillas in El Salvador

Antonella Bandiera, Lelys I. Dinarte Diaz, Juan Miguel Jimenez, Sandra V. Rozo & Maria Micaela Sviatschi in this nber paper study impact of rebel governance on economic development:

How does territorial control by non-state actors affect long-term development? We investigate the economic, social, and political consequences of temporary territorial control by guerrillas during the Salvadoran Civil War. During this period, these guerrillas displaced state authorities and promoted the creation of self-governing institutions that were highly representative of local community values and showed open distrust of the state and elites.

Using a spatial regression discontinuity design, we show that areas exposed to guerrilla control have experienced worse economic outcomes over the last 20 years relative to areas adjacent to these locations that were controlled by the formal state.

Our results suggest that informal participatory institutions in guerrilla-controlled areas led to the persistence of land fragmentation and disengagement with the government. We argue that when non-state actors develop governance institutions as an alternative to the state, it can lead to negative effects on development through persistent norms of distrust towards out-groups, even after they relinquish control.

Macroeconomics of the 2020s: What we’ve learned, and what’s to come

Paul Beaudry, Deputy Governor of Bank of Canada in this speech reflects on lessons from macroeconomics of the 2020s.

When COVID-19 first hit, the Bank of Canada—and many other central banks—took a series of actions. Some were new and innovative in response to the situation before us. Others stemmed from the playbooks we used during other crises. This is a key approach to policy-making: we draw from past experiences to figure out what actions will best support the economy, keep inflation on target and protect the well-being of households and businesses.

Looking back now, I believe we got a lot of things right when trying to manage the economic fallout from the pandemic. But in other areas, we could have done better.

So today, with the benefit of hindsight, I want to talk about some early lessons we can draw from this episode. I’ll discuss what worked, and where we could improve our response to future downturns.1

I’ll focus specifically on three issues.

The first is how international spillovers have been shaping the macroeconomic landscape. Here I’m thinking about how countries responded to and are recovering from the pandemic, and how policy-makers’ actions in individual countries affected global outcomes. And I’ll emphasize how cross-country interactions played out differently during the pandemic than they did in other recessions, such as the one that followed the 2008–09 global financial crisis (GFC).

Second, I’d like to compare the strong rebound that we’ve seen in the labour market with the jobless recoveries that advanced economies sometimes experienced in the past. Here I’ll stress how these differences partly reflect the way policy shaped the evolution of public and private sector balance sheets.

Finally, I’ll look ahead to an issue on so many minds these days: inflation. Just this morning new numbers were released. In August, inflation stood at 7%. While we’re headed in the right direction, that’s still too high. Consumers and businesses are rightfully wondering when we’ll stop feeling the pinch of high prices. And so I’ll talk about the role that expectations play in driving inflation, how central banks try to influence those expectations and what this means for the Bank of Canada as we guide inflation back to our 2% target.

He says the response to the pandemic shock was driven by the 2008 crisis. both the shocks were different:

A distinctive feature of the GFC was that many sectors and countries were left facing levels of demand well below available supply, and for extended periods of time. This excess capacity meant that price pressures associated with stimulus measures were modest. The inflation dimension was therefore a relatively small part of the overall story during this period.

The COVID-19 crisis was clearly very different. Even when countries were experiencing excess supply overall, key sectors were operating at or near capacity limits, including many sectors that rely on internationally traded goods. Bottlenecks occurred in these sectors because of demand surges driven by a combination of stimulus policies, shutdowns and re-openings as well as by consumers shifting away from services.

We should have withdrawn the stimulus faster this time aorund:

Normally when demand goes up following a recession, supply responds strongly. But during the pandemic, supply couldn’t keep up because of public health protocols and shutdowns. This caused delays in consumers getting their hands on goods like bicycles and furniture. So prices rose more sharply than usual.

Compared with the GFC, this resulted in a stronger response on the inflation dimension and a weaker response on the activity dimension. So one country’s decision to maintain stimulus disproportionately impacted others through the effects of that stimulus on the prices of globally traded goods.

For instance, as US stimulus spread through the economy and led to a greater demand for new vehicles, Taiwan—a key manufacturer of microchips needed to make modern vehicles—was struggling to adapt its production processes and facing long backlogs of orders. Instead of stimulus-induced demand leading to more output, this bottleneck meant global automobile production stalled and prices increased—not only in the United States, but also in Canada and around the world.

The net result was that, during the recovery phase of the pandemic, it’s likely a somewhat faster global withdrawal process could have made all countries better off.

To summarize, lessons from the GFC informed key parts of the policy response to the pandemic. However, in hindsight, policy-makers everywhere should have been more alert to the possibility that the nature of global spillovers can change over time. A better understanding of these dynamics and how policy actions can ripple around the world should enable more effective global responses to future shocks.

Lets see which lessons will apply in next crisis.

I also like the way dg has mentioned macroeconomics of 2020s. we need to teach and reflect on macroeconomics based on time periods macroeconomics of 1930s, macroeconomics of 1970s. macroeconomics of 2008-19, macroeconomics of 2020s and macroeconomics of 2022.

Ethics of currency – a possible guide for central bankers?

Mr François Villeroy de Galhau, Governor of the Bank of France, gave the Michel Camdessus Central Banking Lecture organised by IMF.

It is my great pleasure to be in Washington with you today, and to deliver this speech in honour of Michel Camdessus. I would like to take this opportunity to pay a special tribute to him, and express my personal gratitude. Michel is not only one of my predecessors as a Governor of the Banque de France, but also a friend of mine and – yes – a master. My speech was prepared with his precious help, so today you can almost enjoy a “Camdessus Lecture by Michel Camdessus himself”.

The somewhat unusual theme I proposed for today, the “ethics of currency”, has guided him throughout his career. In the murky waters that we central bankers are navigating, it should more than ever serve as a golden thread. I will briefly discuss the reasons why I dare to talk about the ethics of currency (I), then elaborate in practice on the golden triangle of trust today (II) and finally raise the question as to whether the international dimension of trust can still inspire us (III).

What is ethics of currency? what is ethics?

Before going any further, we must find a common definition of “ethics”. Is it possible to take this word as a synonym for “morality”? For centuries, this question has been the “bridge of donkeys” (pons asinorum) for philosophers’ apprentices. Supporters of the synonym theory highlight a common etymology between the two words – morality is the Latin translation of Greek ethos. Despite their initially identical meanings, the two words nevertheless have followed different paths over time: “morality” can be described as a “hard concept”, similar to the fundamental rules engraved on Moses’ stone tablets or in the code of Hammurabi. In contrast, “ethics” refer to a softer and less binding concept, a kind of existential version of morality with a more personal dimension.

I will use the word ethics in that way in this speech. The question of interest rates is a noteworthy example of the way a moral prohibition can evolve into a more flexible and ethical approach. From a moral overall ban, ethically “fair” interest rates have been progressively distinguished from usury rate, with the latter still being forbidden.

“Homo economicus” invented currency very early in human history, and it is striking that almost as soon as currency was born, countless abuses were seen as well: manipulation of gold or silver weight in coins, skewing of scales, and so forth. Men therefore quickly summoned ethics to define how to govern its use. However, human kind has also shown a tendency to exempt itself from the rules it had previously established, before setting new rules again in order to respond to the problems caused by deregulation.

….

Another distinction is between the ethics of money and of currency. The ethics of money are customary and widespread, and can be summed up by the words of Alexandre Dumas, a famous French writer: “money is a good servant but a bad master”. The ethics of currency that interest me today are obviously part of this, but are perhaps less common. They have two specific features: (i) the importance of institutions, of the “sovereign” dimension: there is no currency without a public authority that guarantees it and is responsible for it (ii) the importance of trust, which can be defined as being able to count on the character, ability, strength or truth of someone or something.  Today, we central bankers are responsible for trust: we “produce” it, and we stand accountable for it. Such a responsibility entails a strong personal component: our behaviour has to be flawless, and driven by real functional requirements and high ethical standards. But let me today focus on the institutional and collective foundations of trust.

hmm..interesting way to look at currency and money…

Monetary Policy Independence under a Flexible Exchange Rate Regime – The Indian Case

Harpreet Singh Grewal and Pushpa Trivedi in this rbi working paper analyse whether forex interventions have influenced rbis monetary policy:

In an open economy, central banks confront the impossible challenge of simultaneously preserving exchange rate stability, conducting independent monetary policy, and benefitting from an open capital account.

Against this backdrop, the paper assesses whether the foreign exchange market interventions by the RBI to contain the volatility in INR have had any constraining influence on India’s monetary policy independence during 1991 to 2020.

The major findings of the paper are:

1. 1. There is a high degree of sterilisation of the increase in money supply that results from forex market interventions in India.
   2. Forex market interventions during surges in capital flows to contain the INR volatility lead to an increase in M₃, which however is found to be neither inflationary nor elicits a policy rate response by the RBI; this points to RBI’s monetary policy independence not facing much constraints from its exchange rate policy and financial openness.

Economic research at central banks: Are central banks interested in the history of economic thought?

Ivo Maes of National Bank of Belgium in this working paper:

A research department is now a core element of any modern central bank. This was not always the case. The growth of research departments in central banks is closely related to their transformation from issuing banks, with more commercial tasks mainly relating to discount credit, into modern monetary authorities. It is also related to the need for the management of the monetary system, especially after the demise of the Gold Standard.

Moreover, the growth of research departments, not only in central banks, is an expression of the growing importance of a more systematic and scientific approach in modern society. In the European Union, the importance of academic research for central banks was reinforced by the creation of the European Central Bank, which started operating in June 1998.

Two elements are clearly important for any modern central bank research department: contributing to monetary policy-making and sustaining a dialogue with the academic community. Research departments fulfil very much a bridging function between monetary policy-making and the academic world. This is more or less a constant in the history of central banks.

As part of a pluralist approach towards research, historical research can have important benefits.

Firstly, a historical perspective can offer insights into the relative strengths and weaknesses of  economic theories. Theories are techniques of thinking and remain partial. So, it is important to select theories which highlight the relevant features of reality. The great Austrian economist Joseph Schumpeter approvingly referred to Jules Henri Poincaré’s observation, “tailors can cut suits as they please; but of course they try to cut them to fit their customers”.

Secondly, for policy-makers, the policy regime is of crucial importance. Sometimes, one tends to take the policy regime as given, rather
ignoring that a change in regime will affect economic events and policy outcomes. At other moments, on the contrary, there are heated discussions about the policy framework.

In both cases, thorough economic research can help central bankers to build a robust economic policy framework. A broad historical approach, which can offer some distance and a wider variety of experience, has a role to play.

hmm..

I strongly think that all central banks should have dedicated researchers in economic history and history of economic thought.

Australia central bank has negative equity due to losses from bond holdings, but nothing to worry

Michele Bullock, Deputy Governor of reserve bank of australia iin this speech highlights how bond losses have led to erosion of central bank’s equity:

I am going to use my time to talk about two issues: the review of our bond purchase program (BPP) during the pandemic; and the Bank’s financial statements for 2021/22. The two issues are related because, while the bond purchase program was a policy response to extraordinary economic circumstances, it has had big implications for the Bank’s balance sheet, profits and capital.

I will give you the punch lines up front. In terms of the BPP, the review concludes that it broadly achieved its aims. But one result of the change in the Bank’s balance sheet is that the Bank will report a substantial accounting loss in its 2021/22 annual accounts and, as a consequence, negative equity. This will not, however, affect the Bank’s ability to operate effectively or perform its policy functions. And over the next few years the Bank will return to positive earnings and to positive equity.

Details

In 2021/22 the Reserve Bank recorded an accounting loss of $36.7 billion. While underlying earnings were $8.2 billion, valuation losses were $44.9 billion. Only $0.5 billion could be absorbed by the UPR so there still remained $36.2 billion in losses to distribute. The RBRF absorbed $15.4 billion of this before it was exhausted, leaving around $21 billion in losses. This will be recorded as accumulated losses on the Bank’s balance sheet (Table 2). This means that the Bank has negative equity.

Table 2: Distribution of RBA Accounting Loss in 2021/22

$ billion

– Accounting loss		−36.7
– Absorbed by:
– Unrealised profits reserve		−0.5
– Reserve Bank Reserve Fund		−15.4
– Transferred to accumulated losses		−20.8
– Other reserves		8.4
– Net equity		−12.4

If any commercial entity had negative equity, assets would be insufficient to meet liabilities and therefore the company would not be a going concern. But central banks are not like commercial entities. Unlike a normal business, there are no going concern issues with a central bank in a country like Australia. Under the Reserve Bank Act, the government provides a guarantee against the liabilities of the Reserve Bank. Furthermore, since it has the ability to create money, the Bank can continue to meet its obligations as they become due and so it is not insolvent. The negative equity position will, therefore, not affect the ability of the Reserve Bank to do its job.

Indeed, a number of central banks in other countries have a similar issue – large bond portfolios that, if marked-to-market, will result in substantial accounting losses and, potentially, negative equity. But the Reserve Bank of Australia is unusual in using market value accounting without an indemnity from the Government. For example, both the Bank of England and the Reserve Bank of New Zealand use market value accounting for securities purchased under their equivalent bond purchase programs but their profits are unaffected by mark-to-market gains or losses because they are offset by a matching entry that reflects the value of their indemnity.^[7]

times remain interesting…

Central Bank Independence and Inflation in Latin America—Through the Lens of History

Luis Ignacio Jácome and Samuel Pienknagura in this IMF working paper trace evolution of central bank independence in latin america and its impact on inflation:

We study the link between central bank independence and inflation by providing narrative and empiricial evidence based on Latin America’s experience over the past 100 years. We present a novel historical dataset of central bank independence for 17 Latin American countries and recount the rocky journey traveled by Latin America to achieve central bank independence and price stability.

After their creation as independent institutions, central bank independence was eroded in the 1930s at the time of the Great Depression and following the abandonement of the gold exchange standard. Then, by the 1940s, central banks turned into de facto development banks under the aegis of governments, sawing the seeds for high inflation. It took the high inflation episodes of the 1970s and 1980s and the associated major decline in real income, and growing social discontent, to grant central banks political and operational independence to focus on fighting inflation starting in the 1990s.

The empirical evidence confirms the strong negative association between central bank independence and inflation and finds that improvements in independence result in a steady decline in inflation. It also shows that high levels of central bank independence are associated with reductions in the likelihood of high inflation episodes, especially when accompanied by reductions in central bank financing to the central government.

Latin america is one region where lessons from central bank independence and its impact need to be studied and taken seriously.

Is implied Volatility Index (VIX) a forward-looking indicator of stock market movements in India?

Amarendra Acharya, Subrat Kumar Seet and Prakash A. Salvi in this new rbi working paper

There is a conventional belief that the stock price index and the underlying implied volatility index move in opposite directions. However, on some occasions in the recent past, they displayed co-movements, casting doubts about the future course of action for investors. This paper explores various aspects of this relationship in the Indian context over a decade-long period and compares them with the available findings for the US.

It finds that negative returns in the stock index generate larger changes in implied volatility as compared to positive returns. The size of the return also influences the relative change in the implied volatility index. Further, it is seen that higher levels of volatility influence buying decisions of the investors at a duration of 20- and 60- days. Such behaviour indicates that the Indian stock market is forward-looking to an extent and resembles the pattern observed in the US.

Deficit financing to financing deficits

On March-1997, the government and RBI signed an agreement to end 4 decades of deficit financing.

In my article in financial express, I write on the 25 years of the landmark agreement.

Impact of pandemic on Economic Activity across Indian States

RBI researchers Sudhanshu Goyal, Akash Kovuri and Ramesh Golait in this research article analyse the impact of pandemic on Indian states:

The article constructs a composite index using a set of lead indicators to capture trends in economic activity at the State level and analyses how economic activity responded to restrictions in mobility during the pandemic.

Highlights:

1. 1. There was considerable variability in the extent of mobility restrictions across States during the pandemic. Also, trends in economic activity varied across States.
   2. States which are more dependent on agriculture, forestry and logging witnessed a relatively benign impact of mobility restrictions on economic activity. States with high share of manufacturing and services in their gross state value added (GSVA), however, witnessed relatively higher impact on economic activity.
   3. Thus, economic activity responded differently to mobility restrictions across States and the varied impact could be attributed to different economic structures. This underscores the role of State-specific interventions, tailored to their economic structure, in supplementing the national level policy response.

Cyber risk in central banking

Sebastian Doerr, Leonardo Gambacorta, Thomas Leach, Bertrand Legros and David Whyte raise an important research issue – cyber risks in central banks:

The rising number of cyber attacks in the financial sector poses a threat to financial stability and makes cyber risk a key concern for policy makers. This paper presents the results of a survey among members of the Global Cyber Resilience Group on cyber risk and its challenges for central banks.

The survey reveals that central banks have notably increased their cyber security-related investments since 2020, giving technical security control and resiliency priority. Central banks see phishing and social engineering as the most common methods of attack, and the potential losses from a systemically relevant cyber attack are deemed to be large, especially if the target is a big tech providing critical cloud infrastructures. Generally, respondents judge the preparedness of the financial sector for cyber attacks to be inadequate.

While central banks in most emerging market economies provide a framework for the collection of information on cyber attacks on financial institutions, less than half of those in advanced economies do. Cooperation among public authorities, especially in the international context, could improve central banks’ ability to respond to cyber attacks.

 

Making a virtue out of necessity: the effect of negative interest rates on bank cost efficiency

Giuseppe Avignone, Claudia Girardone, Cosimo Pancaro, Livia Pancotto and Alessio Reghezza in this ECB paper look at impact of negative interest rates on bank efficiency-

Do negative interest rates affect banks’ cost efficiency? We exploit the unprecedented introduction of negative policy interest rates in the euro area to investigate whether banks make a virtue out of necessity in reacting to negative interest rates by adjusting their cost efficiency. We find that banks most affected by negative interest rates responded by enhancing their cost efficiency.

We also show that improvements in cost efficiency are more pronounced for banks that are larger, less profitable, with lower asset quality and that operate in more competitive banking sectors. In addition, we document that enhancements in cost efficiency are statistically significant only when breaching the zero lower bound (ZLB), indicating that the pass-through of interest rates to cost efficiency is not effective when policy rates are positive.

These findings hold important policy implications as they provide evidence on a beneficial second-order effect of negative interest rates on bank efficiency.