How high interest rates reveal the weaknesses of banks?

The end of historically low interest rates has been described as good news for banks, which make more money as the difference between what they charge borrowers and what they pay for financing widens, but recent crises in the banking sector show that the reality is more complex.

A report – published by the British " Financial Times " magazine – stated that some banks, especially in Europe, are stuck in large loan books at fixed interest rates that are much lower than current levels, where others who have a higher share of their book at variable rates can immediately charge more. of loans due but risk a wave of defaults from borrowers who can no longer afford to service their debts.

He added that there is also the issue of government bonds, as banks retain more liquidity after the post-financial crisis regulations limited risk, as the value of bonds that were purchased a year ago decreased because they offer lower interest rates than those sold today, which is a good thing unless you have to. Banks to sell them to meet depositors' requests.

Bond portfolio losses

Banks have been buying ultra-safe government debt as a way to meet regulatory requirements to hold a sufficient amount of high-quality liquid assets, but rising interest rates have sharply reduced the value of these bonds, with the Federal Reserve saying US banks have $620.4 billion in portfolio losses. Its due end of 2022. Under US rules, lenders do not have to factor in market-related losses in their earnings or equity ratios, so most did not hedge against that possibility.

And when a bank finds itself short on liquidity to meet deposit outflows – as happened to Silicon Valley Bank (SVB) – it may be forced to sell part of its "held-to-maturity" portfolio, which could cause investors and depositors to worry.

Fixed rate loans

Rising interest rates pose a dual challenge to the lending side of banks' asset books. Those able to pass rate increases on to customers – via variable-rate loans – enjoyed a significant rise in profits in 2022, as fixed-rate loans have less chance of default but are It also represents a burden on the profitability of banks, whose financing costs will increase.

Loans with variable rates are becoming more common in the eurozone, but fixed-rate mortgages still account for about 3-quarters of the total, according to data from the European Central Bank, while the picture appears more complex in the United States, where adjustable-rate mortgages represent less than 10%. of total mortgages, but represents 36% of those on banks' balance sheets, according to data from the Federal Deposit Insurance Corporation.

own assets

One area of focus is the banks' relationship with the burgeoning world of private credit, where leveraged loans are at the top of regulators' watch lists, which private equity groups typically use to fund their acquisitions.

Leveraged loans typically combine high leverage, strong repayment assumptions, weak covenants, or terms that allow borrowers to build up debt, including drawdowns on additional facilities.

Credit to hedge funds – which have made big bets on interest rates – is another area that banks are watching closely.

deposit outflows

When interest rates and inflation rise, savers expect their deposits to perform better, but this is not always the case in banks, which may prompt customers to take their money elsewhere. In the United States, total bank deposits decreased by 3.3% since the “Fed” began raising interest rates last year, and this decline accelerated shortly after the collapse of Silicon Valley and Signature banks, as deposits in US banks decreased, the seven days to March 15. , which is equivalent to its decrease during the year.

In the eurozone, depositors withdrew 214 billion euros over the past five months, or 1.5% of total deposits, according to data published by the European Central Bank this week. The decline accelerated in February, the latest month for which data is available, as depositors reduced their holdings by 71.4 billion euros, the largest monthly decline since records began in 1997.

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