New Look at Global Banks Highlights Risks From Higher-for-Longer Interest Rates

IMF Blog, October 16, 2023

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Central banks could keep interest rates higher for longer to curb inflation that remains stubbornly high in many countries, which may slow economies.
This interest-rate environment is unprecedented in a generation for global financial markets and requires sharpened analytical tools and regulatory responses.
IMF enhancements: stress-testing tools focused on rising interest rates and funding pressures; a new surveillance tool using analyst forecasts and traditional bank metrics; these tools use public data to complement supervisory stress tests and IMF-World Bank Financial Sector Assessment Programs.

Banks can benefit by collecting higher interest rates from borrowers while keeping deposit rates low.
Risks:
- Loan losses may increase as consumers and businesses face higher borrowing costs, especially if they lose jobs or revenues.
- Banks’ holdings of bonds and other debt securities lose value when interest rates rise, potentially forcing sales at a loss under sudden deposit withdrawals or funding pressures.
- The failure of Silicon Valley Bank exemplified the bond-loss channel.
Central bank lending facilities, such as the Federal Reserve’s discount window, can reduce losses from forced securities sales under deposit-run scenarios.

Scope: almost 900 lenders across 29 countries.
Baseline scenario (aligned with the latest IMF World Economic Outlook) identified:
- 30 banking groups with low capital levels, together accounting for about 3 percent of global bank assets.
Severe stagflation scenario (high inflation with a 2 percent global economic contraction and even higher central bank interest rates) results:
- 153 weak institutions, accounting for more than a third of global bank assets.
Geographic pattern:
- Excluding China, there are many more weak banks in advanced economies than in emerging markets.

Tool inputs: traditional supervisory metrics (e.g., ratio of capital to assets) and market indicators (e.g., market price to book value of bank equity).
Flagging rule: banks flagged for further review if outliers across three or more of five risk metrics—capital adequacy, asset quality, earnings, liquidity, and market valuation.
Back testing outcomes:
- Surge of potentially vulnerable institutions at the onset of the pandemic.
- Sustained rise in late 2022 as higher interest rates began to bite; this latter group included the four banks that either failed or were taken over in March.
Current indicators (market data and consensus analyst forecasts) point to:
- A substantial group of smaller banks at risk in the United States.
- Concern for some lenders in Asia, including China, and Europe as liquidity and earnings pressures persist.

Stress testing:
- Supervisory stress tests should include market-based analysis.
- Tests should include smaller lenders.
- Scenarios should be more severely adverse yet still plausible.
Supervisory capacity:
- Bank supervisors need to be proactive and ready to address identified weaknesses.
- More than half of economies do not have independent bank supervisors with adequate resources (per IMF Financial Sector Assessment Program findings).
Regulatory standards:
- International standards need raising to manage liquidity and interest rate risks in banks.
- At least one-fifth of economies have weak supervisory and regulatory practices to monitor and address these risks.
Central bank access:
- Banks should be better prepared to access central bank lending facilities.
- Banks should periodically test such access while supervisors assess whether weaker lenders can easily tap emergency assistance.

Use the current lull in banking strains to increase resilience in banks, regulators, and supervisors.
Prepare for a possible resurgence of banking risks if interest rates stay higher for longer than currently priced in markets.

—This blog is based on Chapter 2 of the October 2023 Global Financial Stability Report, “A New Look at Global Banking Vulnerabilities.”