Europe’s financial authorities are quizzing lenders about their exposure to rapidly rising interest rates, as they investigate how much this risk may spread beyond the banking sector.
Andrea Enria, chair of the European Central Bank’s supervisory board, said the bank was looking at whether unrealised losses on lenders’ bond portfolios, the value of which have sunk as borrowing costs have risen, could erode their capital base in a crisis.
Enria told an event organised by news and data provider MNI on Tuesday that the ECB would ask banks how much of their so-called “interest rate risk” they had insured by buying hedging products in financial markets. The supervisor was also asking lenders to list the top 20 counterparties that had taken the other side of these contracts.
The hedging strategies are being probed as part of the supervisor’s stress test of eurozone banks this summer, according to Enria. Regulators are concerned that the hedges could mean the risk of rising interest rates has been shifted outside the banking sector, such as to hedge funds or insurance companies, where they have less visibility.
The information collected by the ECB on unrealised bond losses will not directly affect the results of the stress test and supervisors are yet to decide if they will publish the data separately.
The move comes after global supervisors underestimated the potential for soaring interest rates to have an impact on the banking system.
Last year, the ECB asked banks to model the impact of a 2 percentage point increase in borrowing costs on the value of their bond portfolios — lower than the 3.5 percentage point rise that has occurred since last summer.
The renewed focus on interest rate risk comes after Silicon Valley Bank became the second-biggest bank failure in US history after deposit withdrawals forced it to sell $21bn of government bonds at a big loss, eroding confidence and causing the run on the lender to accelerate.
The supposedly safe bonds were worth less than SVB paid for them because of the sharp rise in US borrowing costs.
Enria said eurozone banks had a “significant” amount of assets that — like at SVB — were accounted for as if they would be owned to maturity, meaning that losses did not have to be booked.
Three-quarters of the €2.8tn in government bonds owned by eurozone banks in December were accounted for in this way, Enria said. This was “definitely a point of attention”, he said.
But he added that the size of these unrealised losses for eurozone banks was “in a different ballpark” to the larger-scale problem in the US.
The IMF estimated in this month’s financial stability report that such unrealised losses at a sample of US banks would knock about 2.5 percentage points off their capital, while the equivalent capital hit to European banks was about 0.5 percentage points.
Germany’s municipally owned savings banks said last month they had booked €7.8bn of losses to account for the impact of higher interest rates on their bond portfolios. The figure amounts to 4.3 per cent of their total capital.
The latest eurozone banking stress test, which models the impact of a severe recession and a sharp rise in borrowing costs, started in January and the results are due to be published in July.