Steven B. Kamin Director, International Finance Division Federal - - PowerPoint PPT Presentation

Steven B. Kamin

Director, International Finance Division Federal Reserve Board October 2018

Financial Stability Implications of a Prolonged Period of Low Interest Rates

Disclaimer: This presentation represents my own views and not necessarily those of the Federal Reserve Board of Governors or its staff.

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Advanced economy (AE) policy normalization expected to proceed slowly.

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Implications of prolonged low interest rates for financial stability

Might a further prolonged period of very low rates:

• reduce viability of financial institutions?
• incentivize risk-taking?
• increase vulnerability to a subsequent snapback in rates?
• threaten financial stability?

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BIS Study Group

• Bank for International Settlements (BIS) study group:
• Input from 19 central banks; led by Ulrich Bindseil (ECB)

and me.

• Focus on two broad categories of financial institutions:
• Banks
• Life insurance companies and private pension funds (ICPFs)
• Analysis applied to over 20 countries; I’ll be focusing on

examples from U.S. and Japan.

• Report available at: https://www.bis.org/publ/cgfs61.pdf

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Effect of Low Rates on Banks

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Channels Through Which Low Interest Rates Might Affect Banks

• Squeeze net interest margin (NIM) if deposit rates are

stickier than loan rates.

• Lower profits may reduce capital and resiliency.
• Shift to riskier loans (“search for yield”).
• Could lead to future snapback in interest rates that triggers

losses.

Effect of Low Rates on Bank Profits: 3 Scenarios

United States

• Baseline: rates gradually rise to more normal levels.
• Low-for-long (L4L): continued weakness in demand and

inflation keep rates low.

• Snapback: rates later rise sharply in response to higher

inflation.

3 5 2002 2005 2008 2011 2014 2017 2020 2023 2026

Nominal 3-month yield

Baseline Projection Snapback Projection L4L Projection

Percent 4 7 2002 2005 2008 2011 2014 2017 2020 2023 2026

Nominal 10-year yield

Percent

• 4
• 2

2 4 6 2002 2005 2008 2011 2014 2017 2020 2023 2026

GDP Growth

Percent 2 4 6 2002 2005 2008 2011 2014 2017 2020 2023 2026

CPI Inflation

Percent

Source: “Financial Stability Implications of a Prolonged Period of Low Interest Rates,” Committee on the Global Financial System, 5 July 2018.

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• 1

1 2 3 2002 2005 2008 2011 2014 2017 2020 2023 2026

Nominal 3-month yield

Baseline Projection Snapback Projection L4L Projection

Percent

• 1

1 2 3 4 2002 2005 2008 2011 2014 2017 2020 2023 2026

Nominal 10-year yield

Percent

• 8
• 6
• 4
• 2

2 4 6 2002 2005 2008 2011 2014 2017 2020 2023 2026

GDP Growth

Percent

• 3
• 2
• 1

1 2 3 4 5 6 2002 2005 2008 2011 2014 2017 2020 2023 2026

CPI Inflation

Percent

Japan

Effect of Low Rates on Bank Profits: 3 Scenarios

Source: “Financial Stability Implications of a Prolonged Period of Low Interest Rates,” Committee on the Global Financial System, 5 July 2018.

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Projections of Bank Profits in Different Scenarios

• Net interest margins (NIMs) would fall materially in a low-

for-long (L4L) scenario compared with Baseline.

• But overall profitability -- return on assets (ROAs) -- would

not.

1 2 3 4 2001 2005 2009 2013 2017 2021 2025

NIMs

Baseline L4L projection

Percent

• 1.0
• 0.5

0.0 0.5 1.0 1.5 2001 2005 2009 2013 2017 2021 2025

ROAs

Baseline L4L projection

Percent U.S. Japan U.S. Japan

Source: “Financial Stability Implications of a Prolonged Period of Low Interest Rates,” Committee on the Global Financial System, 5 July 2018.

40 60 80 100 1998 2002 2006 2010 2014 0.0 1.0 2.0 3.0 4.0 5.0 2000 2003 2006 2009 2012 2015

Years

20 40 60 80 100 120 140 1963 1973 1983 1993 2003 2013

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Limited Signs of Low Rates Encouraging Risk-Taking

• 3. Bank Credit to Private Sector

U.S. Japan

• 2. Credit-to-Deposit Ratio

GFC GFC

• Banks in some economies have shifted assets toward longer maturities

(panel 1); also increased concentration in real estate loans.

• But credit-to-deposit ratios have declined (panel 2), and bank credit-

to-GDP ratios are also subdued.

• Bank capital is up everywhere after the GFC.

Percent of GDP

Other Advanced Economies U.S. GFC

• 1. Weighted-Average Maturity of

Bank Assets U.S. Japan

Percent

Source: “Financial Stability Implications of a Prolonged Period of Low Interest Rates,” Committee on the Global Financial System, 5 July 2018.

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So, limited adverse effects of low rates, but some points

• f concern…
• Concern 1: Rate sensitivity of bank profits stronger when:
• Yields already low.
• Banking more competitive.
• Banks depend heavily on deposit funding.
• Thus, regional banks in Japan.
• Concern 2: Subdued risk-taking may not continue.
• Recent experience reflects de-risking and tightening of standards and

regulations in wake of the GFC.

• 150
• 100
• 50

50 100 150 200 250 2016 2017 2018 2019 2020 2021

2016 = 100

Baseline Low-for-Long Snapback Snapback + Real Estate Shock

Net Earnings Projection: Switzerland

• Concern 3: Future snapback in

interest rates could lead to valuation and credit losses.

Source: “Financial Stability Implications of a Prolonged Period of Low Interest Rates,” Committee on the Global Financial System, 5 July 2018.

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Insurance Companies and Pension Funds (ICPFs)

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Key Findings for ICPFs

• Low rates undermine ability of some insurance companies and

pension funds to make promised payments, threatening their viability.

• However, deterioration in condition will be gradual, allowing

time to adjust business models and exit unprofitable activities.

• Japanese insurers have already faced low-for-long rates, and

systemic impact proved containable.

• Insurance company bankruptcies of the 1990s addressed without

significant contagion to the financial system.

• Japanese insurers have adjusted business models so as to

maintain viability.

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Overall financial stability and policy implications of prolonged low interest rates

• Financial institutions should generally be able to cope with

prolonged low rates,

• But this will require concerted attention and adjustment by

firms’ management,

• As well as close monitoring by regulators.

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Thank you!