Low market interest rates for a long time could have implications for financial stability as well as for the health of individual financial institutions, a report by the Committee on the Global Financial System finds.
Financial stability implications of a prolonged period of low interest rates identifies channels through which a “low-for-long” interest rate scenario might affect the health of banks, insurance companies and private pension funds.
This scenario would be harder on insurers and pension funds than on banks. Even though the CGFS analysis did not show that measures of firms’ financial soundness dropped significantly, prolonged low rates could still involve material risks to financial stability. In particular, a “snapback”, involving an unexpected sudden increase in market rates from currently low levels, could affect banks’ solvency and create liquidity issues for insurers and pension funds.
“A key takeaway is that, while a low-for-long scenario presents considerable solvency risk for insurance companies and pension funds and limited risk for banks, a snapback would alter the balance of vulnerabilities,” said CGFS Chair Philip Lowe, Governor of the Reserve Bank of Australia.
“The first line of defence against these risks should be to continue to build resilience in the financial system by encouraging adequate capital, liquidity and risk management. But the report also underscores the need to monitor institutions’ exposures in a comprehensive way, including through stress tests.”
The CGFS is a central bank forum for the monitoring and analysis of broad financial system issues. It supports central banks in the fulfilment of their responsibilities for monetary and financial stability by contributing appropriate policy recommendations.