The relationship between interest rate movements and bank margins has been confirmed by an international survey, but the effect on profitability was found to be less than in previous studies. The International Banking Research Network, to which the Reserve Bank of Australia is a contributor, collected data from 1500 banks operating in 10 banking systems covering the 20 years up to the end of 2019. This was a period of falling interest rates and the study confirmed that falling rates reduced banks’ net interest margins. On average, a 100 basis point fall in short-term rates resulted in a five bps decline in net interest margins, which the report said was a smaller impact than in previous studies. Lower interest rates erode margins because most bank assets earn a rate of interest that varies to some extent with the policy rate. The report said the impact on margins could be larger in low-rate environments, when rates are at or near their lower bounds. This is because of the lower proportion of deposits at low rates that banks can reprice lower in line with lending rates. The impact on NIM will vary according to the amount of the bank’s funding that comes from equity, and also the slope of the yield curve – as banks’ loans have longer durations than their liabilities. Other variables include the composition of a bank’s liabilities, the mix of fixed rate and variable rate lending, the use of hedging and competition. While the relationship between rate movements and NIM is relatively straightforward, the link between monetary policy and profitability is less clear.  Offsetting the impact of lower NIM in a falling rate environment, lower rates can reduce loan-loss provisions as a result of lower default probabilities – giving the bottom line a boost.  And banks can respond to lower rates by increasing their non-interest income. This is more likely to be the case with large banks, which have more complex business models. A literature review in the report found some papers that argued that the effect of interest rate movements on bank profitability was negligible “We find that the effect of falling interest rates on return-on-asset metrics is smaller than on NIM, suggesting that banks have found ways to offset the effect of lower interest rate margins,” the report said.