Dhe turnaround in interest rates has struck. It shakes banks and raises new concerns about retirement provision. And construction almost comes to a standstill. Financing is considered the fuel of the real estate industry. This machine is now running sluggishly. In addition to the turnaround in interest rates, banks are demanding more equity and providing less financing volume. Projects are delayed or cancelled. The real estate industry is an example of what happens on the markets when interest rates change very quickly. The interest rate risk, which is only a theoretical value in the long phase of falling interest rates, has a full impact. The collapse of the Silicon Valley Bank, which had to sell government bonds well below the purchase price after investors pulled out, is only the most violent example so far.
In September, the Bank of England, which was only marginally noticed in this country, had to launch a program of 65 billion pounds to stabilize the British pension system. Pension funds had to raise liquidity because the derivatives they had used to protect themselves against low interest rates suddenly lost value. The triggers were thoughtless statements by Prime Minister Liz Truss, who will soon resign, about tax cuts. The nervousness was palpable.
Increased vulnerability
Banks and insurers, the powerful branches of the financial sector, had warned that after years of easy monetary policy, an abrupt rise in interest rates could be necessary to get inflation under control. A gradual exit from unconventional bond purchases and ultra-low interest rates would be better. Now the fears are confirmed. “Even highly liquid government bonds are not safe, which is a problem for some banks because they have a price risk,” says Hans-Peter Burghof, Professor of Banking at the University of Hohenheim.
The rise in interest rates since the beginning of 2022 is one of the steepest in history – regardless of whether it started a little earlier, as in the USA, or later, as in the euro area. When financial service providers hold bonds, this leads to losses in value that are sometimes serious, sometimes less so. “Due to the rapid pace of monetary policy corrections, we are in a phase of increased vulnerability,” says Burghof. “But it only becomes effective when there is a lack of liquidity.” This problem brought the Silicon Valley Bank to its knees. It had to compensate for the lack of liquidity by selling bonds – losses in value were realised. Had it been able to hold paper to maturity, losses would have been offset.
Interest rate risk is more relevant for banks than for insurers. Although both hold bonds, banks convert short-term deposits into long-term loans and investments via maturity transformation. Due to regular premium income, life insurers have less liquidity requirements and can usually hold paper until maturity because they only have to make a payment at the end of the contract term.
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