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October 10, 2017

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ECB says banks ready for rising rates

THE European Central Bank says banks under its jurisdiction appear well-prepared to face unexpectedly higher interest rates, but may be less ready for disruption from online banking.

The ECB’s banking supervision division released results yesterday of a stress test that showed suddenly rising rates would increase net interest income, an important part of bank finances.

Earnings at some banks have lagged due to the current very low interest rate environment that squeezes the margins between rates at which banks borrow and their lending rates.

The central bank said that in a hypothetical interest rate shock involving an increase of 2 percentage points, net interest income would rise by 4.1 percent this year and 10.5 percent next. The stress test imagined a sudden overnight increase. That is a highly unlikely scenario, but one which helps show whether bank finances are robust.

The ECB concluded that “interest rate risk is well managed by most European banks.”

It warned however that many banks are relying on questionable models to predict how their deposit customers might behave. The models were mostly constructed based on the years since 2008, which means they are based on experience from a period of falling rates. Deposits are usually one of the most stable sources of money for banks, and a sudden decision by lots of people to take their money elsewhere could hurt bank finances. That could happen if people chase higher rates elsewhere or get better offers for banking services from so-called fintech firms that use mobile banking, peer-to-peer lending or financial advice dispensed by software. The ECB said it would engage banks in discussion about their models.

The study showed that banks would show losses in the long-term value of their assets, such as investments in bonds and their mortgage business.

The ECB’s bank supervision division is kept separate from its monetary policy duties, so the stress test doesn’t provide any hints about its thinking on the future course of its rate policy.


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