European bank´s Resilience to new interest rate cycle

Luis de Guindos, Vice-President of the European Central Bank (ECB) and Andrea Enria, Chair of the Supervisory Board of the ECB released an article jointly, on the results of the recent ECB´s assessment of European Banks’s resilience in the new phase of monetary policy normalization and the impact of interest rate raises on bank’s balance sheets, profitability, and ability to provide credit to households, small businesses and corporates.

Main takeaways:

• ECB´s assessment under different macroeconomic scenarios shows that the banking sector is sound enough to handle the effects of rising rates on their balance sheets.
  
  
• Banks must prepare for potential longer-term effects related to monetary policy normalisation:
  
  
  • They should pay special attention to interest rate risk in their asset and liability management. The assessment shows how banks’ monitoring of this risk have deficiencies that can be translated into potential incorrect attribution of risks impacting the P&L.
    
    
  • Profitability would increase overall, driven by net interest income but interest rates raise have a negative impact on the economic value of equity in the medium term.
    
    
  • Provisions would also increase, reflecting potential difficulties for the most fragile households and firms in coping with the increase in their debt servicing cost.
    
    
  • Results for the overall impact on solvency remain on average fairly muted with great heterogeneity across banks. Only a few banks, representing 0.1% of the sector’s assets, might react to solvency negative impacts by deleveraging their balance sheet and retracting their support to the economy.