A rise in interest rates could harm 51 big Eurozone banks according to stress tests revealed today by the European Central Bank (ECB).
Banks which are the most exposed could be forced to increase their capital requirements by up to 25 basis points to protect against rising interest rates, the ECB said today.
The ECB’s main interest rate has not risen since 2011, but the central bank is expected to announce a slowing of stimulative asset purchases at its next meeting this month, paving the way for an eventual rise in interest rates once it stops buying bonds.
Some 111 banks were tested under a range of scenarios to work out their banking books’ exposures to interest rate movements, with the ECB noting that the risk was “well managed in most European banks”. Banks with well managed rate risk could see their capital requirements fall.
However, the 51 banks on which the ECB has serious concerns could be forced to hold more capital. The ECB will tailor these requirements to individual firms, with those banks which must increase capital holdings expected to show they are making progress from the coming January onwards.
The banks with issues are not taking into account what will happen when rates rise, having become used to steady falls in the cost of borrowing, the ECB said. The models banks use to work out their risk may be little use once rates rise.
“Most deposit models are based solely on a period of decreasing interest rates and hence might entail high model risk,” the ECB said.
For most banks a rise in interest rates will boost net interest income, the amount banks earn on their lending once it has paid out liabilities.
Net interest income would increase for 76 per cent of the banks tested, but the economic value of equity – a proxy measure of how much the bank can earn from its balance sheet – would fall for 77 per cent of banks.
The hypothetical increase in interest rates of 200 basis points – a steep hike relative to the current zero per cent rate on the ECB’s main refinancing operations – would lead on aggregate to a rise in net interest income of 4.1 per cent in 2017 and of 10.5 cent by 2019, the stress tests showed. However, the economic value of equity would decrease on aggregate by 2.7 per cent.