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.
Its latest quarterly report into 600 listed EU and US banks said there was evidence suggesting that the risk of loan defaults “shot up” when interest rates remained low for long periods prior to the financial crisis.
The report’s author Leonardo Gambacorta said: “We see that when interest rates are low for an extended period, banks’ expected default frequencies tend to increase.
“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.”
The report also said that prolonged interest rates and increased risk taking could lead to new asset price bubbles, particularly in the housing market.
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.
“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,” said Gambacorta.
The report comes as some countries start to tighten monetary policy amid signs of a recovery. Last week,Australia’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.