How rising interest rates are exposing bank weaknesses

07 Apr 2023

The end of historically low interest rates was billed as good news for banks, which make more money as the difference widens between what they charge borrowers and what they pay for funding. But recent crises on both sides of the Atlantic show that the reality is more complex, upending the conventional wisdom.

Some banks, notably in Europe, are stuck with big loan books at interest rates fixed far below current levels. Others with a higher share of their book at variable rates can immediately charge more for outstanding loans but risk a wave of defaults from borrowers who can no longer afford to service their debt.

Then there is the issue of government bonds, where banks have been holding ever more of their liquidity after post-financial crisis regulations curbed their risk-taking. Bonds bought a year ago have fallen in value because they offer lower interest rates than those sold today, which is fine unless banks are forced to sell them to meet depositors’ demands.

Another concern is the unpredictable behaviour of depositors as they look for more lucrative places to park their cash, including money market funds and crypto, if banks are slow to raise rates for savings.