BIS:low rates increase risk

KEEPING interest rates low could encourage banks to take bigger risks, according to a study published by The Bank for International Settlements (BIS) yesterday.<br /><br />Its latest quarterly report into 600 listed EU and US banks said there was evidence suggesting that the risk of loan defaults &ldquo;shot up&rdquo; when interest rates remained low for long periods prior to the financial crisis.<br /><br />The report&rsquo;s author Leonardo Gambacorta said: &ldquo;We see that when interest rates are low for an extended period, banks&rsquo; expected default frequencies tend to increase.<br /><br />&ldquo;The estimation result suggests that if interest rates are maintained below the benchmark for 10 consecutive quarters, the probability of default of an average bank increases by 3.3 per cent.&rdquo;<br /><br />The report also said that prolonged interest rates and increased risk taking could lead to new asset price bubbles, particularly in the housing market.<br /><br />And BIS claims that rising housing prices prior to the banking crisis have added to risk-taking. It found that if house prices were one per cent above their inflation-adjusted long-term average for six back-to-back years, it led to an increased probable default rate of 1.5 per cent for most banks.<br /><br />&ldquo;It is important that monetary authorities learn how to factor in the effect of their policies on risk-taking, and that prudential authorities be especially vigilant during periods of unusually low interest rates, particularly if they are accompanied by other signs of risk-taking, such as rapid credit and asset price increases,&rdquo; said Gambacorta.<br /><br />The report comes as some countries start to tighten monetary policy amid signs of a recovery. Last week,Australia&rsquo;s central bank yesterday hiked interest rates for the third consecutive month by 25 basis points to 3.75 per cent, citing strong employment growth, improving business confidence, and demand from Asia.<br />