A year ago, the US Federal Reserve began raising interest rates to control inflation. The European Central Bank followed suit months later. On the financial front, all seemed calm. After years, commercial banks had the opportunity to widen the spread between interest rates on deposits and loans. The monetary tightening of the central banks gave them the opportunity to improve their interest margin and their profits.
Luis de Guindos and Christine Lagarde
However, a year later, things changed abruptly with the collapse of regional banks in the US and the Swiss giant Credit Suisse in Europe. Something had broken. Rate hikes are not “the cure-all” and have their risks. We are now experiencing the first consequences of extremely low interest rate policies for so many years, replaced by lightning-fast upward adjustment.
These include the slowdown in the economy due to the slowdown in consumption and investment. A higher cost of financing means a weaker real estate market and higher loan delinquency rates. In addition, it entails large losses in the bond portfolios of the banks, where the money of the depositors had been invested, if they have not carried out the pertinent hedging, and the exit of the latter in search of returns higher than those offered by the banks in their deposit accounts, as is the case with Silicon Valley Bank.
Given the stress in the banking sector, financial conditions are likely to tighten, thus reducing the supply of credit and intensifying the risk of recession. The sector’s woes are compounded by stubbornly high inflation, and central banks are torn between maintaining financial and price stability. It is essential that they find a balance.