Interest rates, profitability and risk: Evidence from local Italian banks over the years 2006 - 2018

This paper studies the determinants of net interest margin and of the exposure to the interest rate risk of a sample of 125 local Italian banks during the period 2006-2018. Relative to prior literature, to take advantage of the unprecedented interest rate environment determined by European Central Bank (ECB)'s unconventional monetary policy measures, we consider two sub-periods: 2006-2011 and 2012-2018. Banks' net interest margin increases with the intensity of maturity transformation, with a larger effect in the years 2012-2018, and with their exposure to interest rate risk. At this specific regard, we shed more light than previous studies by distinguishing among three sources of this risk, namely the one referred to the loans issuing and deposits collecting activity, the one stemming from the securities portfolio, and the one associated with derivatives positions. Maturity transformation is associated with an increase in interest rate risk exposure, again with an impact that is stronger over the years 2012-2018. Funding from the ECB is associated with a higher interest rate risk exposure in the years 2006-2011, while it results in a reduction in the second part of the analysed period. We argue that ECB’s (targeted) long-term refinancing operations lead to higher funding stability and strengthen banks’ capacity to withstand potential upward shocks in interest rates. The opposite occurs for the deposits held by our sample bank at the ECB.