Tuesday 23 February 2016 5:08 pm

Top European regulator Daniele Nouy warns low interest rates could push banks into riskier investments

Subdued profitability caused by low interest rates could push banks toward riskier activities, a top European regulator has warned.

“Low profitability is obviously a major concern for the stockholders of banks. And it is also a concern for supervisors. Over the long term, low profitability threatens the ability of banks to generate capital and access financial markets. Ultimately, a lack of profitability affects the stability of banks,” Daniele Nouy, chair of the European Central Bank’s supervisory board, told an audience in London today.

“Weak profitability might push banks into a hazardous search for yield. And we do observe a trend towards higher risk-taking by banks. Certain banks in the euro area have, for instance, invested in leveraged finance such as high-yield bonds.”

She said recent falls in bank shares and concerns over profitability were reflections of “weak economic growth and a prolonged period of very low interest rates.”

Rates could fall further as soon as next month, with the ECB expected to slash the interest rate it pays on deposits further into negative territory.  Nouy said low rates depleted profitability because incomes are correlated to market rates and it is difficult to pass negative interest rates onto customers.

“Earnings on a significant portion of their assets are correlated to market rates; and second, because yields on newly acquired assets are usually well below those of expiring assets. At the same time, banks cannot fully reap the benefits from decreasing funding costs because they tend to avoid paying negative interest on their customer deposits,” she said.

Nouy said that instead of investing in high-risk assets, banks “could expand their non-interest business operations”

“And we indeed observe that banks compensate for lower interest income by increasing their fees.”