Author:

Keywords:

Retail banking, Bank interest margin, Low interest rate environment, Bank profitability, Switching behavior,, Bank competition

Abstract:

This paper presents a game-theoretical model to assess whether banks will introduce negative interest rates to household deposits. This is modelled as a game of incomplete information between two banks which can decrease their interest rates to enhance their interest margins. Savers can decide to stay at their bank, switch to another bank against switching costs, or to use their savings alternatively, such as for investments. We find that banks are more likely to decrease their interest rates if switching costs are higher and the alternatives for savings accounts are less attractive. Surprisingly, we also find that higher switching costs and less attractive alternatives are not necessarily beneficial for banks’ profitability. High switching costs hinder banks to attract savers from competitors and unattractive alternatives may lead to an expensive war of attrition between banks.