Dutch Central Bank Board Member: Rising Interest Rates May Bring Risks for Banking System

10 November 2022

By David Barwick – FRANKFURT (Econostream) – Increased market rates in the wake of European Central Bank monetary policy tightening could also harbour risks for the banking sector, De Nederlandsche Bank  Executive Board member Steven Maijoor said Thursday.

In a speech in Amsterdam, Maijoor, who is responsible for banking supervision at the Dutch central bank, said that banks may be pleased to see market rates finally rising, but that there was a downside to this for them.

‘We have observed the positive effects of the ECB’s tightening stance on interest rate margins as deposit rates have remained around 0% and lending rates have increased in parallel with market rates’, he said. However, this development ‘may also introduce potential risks.’

‘With the current uncertain inflation and geopolitical outlook, further strong and rapid interest rates hikes cannot be ruled out’, he said. ‘Just look at the rapid pace at which the Federal Reserve has been increasing rates in the US. In such a scenario, banks’ assumptions regarding the interest rate sensitivity of deposit funding and the prepayment behaviour of mortgage customers will be tested.’

There was also ‘a deterioration of funding conditions with increasing credit spreads on market funding and TLTRO funding that needs to be repaid’, which could depress net interest income of banks and stoke competition for deposits’, he said.

‘This illustrates that, in the times ahead, a deep understanding of the dynamics in interest rate management, and of the underlying assumptions, will be crucial for banks, but also for us as supervisors’, he said.

Credit losses were another area of high uncertainty for banks, he said. ‘The inflationary shock will have large and diverse income effects’, he said. ‘On top of that, the tightening of monetary policy will increase real interest rates, and this will almost inevitably lead to lower real economic growth, and thus negatively affect banks’ customers, and their ability to pay their loans.’

Moreover, the increase in mortgage rates and weaker household purchasing power could both dampen lending and cause household defaults, he said, which could lead to higher credit losses on mortgage loans.

‘Challenging times lie ahead for the corporate sector, too, especially for those corporates that are not able to adjust to the energy shock, and those that operate in cyclical sectors or in sectors that are sensitive to funding risks’, he said, citing ‘risks that have accumulated as a consequence of the search for yield during the prolonged period of low interest rates.’

‘The leveraged finance portfolios of banks have expanded in recent years and their quality could quickly deteriorate when corporate earnings decrease’, he said.

A particularly challenging aspect of the present situation is the lag with which external shocks materialise completely, he observed.

‘So when and how the current inflationary shocks will have fully rippled through our economy is highly unpredictable’, he said. ‘This will also depend on the fiscal and monetary policy response, and whether or not the geopolitical situation deteriorates further.’