Challenges to financial stability increase as interest rates remain low

Presentation of the 38th Financial Stability Report of the OeNB

Supporting the flow of credit to firms and households, the European Central Bank’s monetary policy measures have, over the past years, provided important stimuli to economic growth in the euro area and in Austria. At the same time, investors have increased their risk exposure given the prevailing low interest rate level, which is, for instance, reflected in shrinking credit risk and term premiums. In the first half of 2019, dynamic lending bolstered Austrian banks’ profits, despite the pressure on interest margins. As financial stability requires sustainable lending standards, especially for real estate loans, banking supervisors continue to monitor these developments closely.

The monetary policy measures of the European Central Bank (ECB) have helped substantially reduce euro area banks’ refinancing costs and have supported the flow of credit to firms and households. At the same time, investors have increased their risk exposure given the prevailing low interest rate level. In this context, shrinking credit risk and term premiums have the potential to distort the pricing of risks. The low interest rates continue to pose a challenge for banks, even though the Eurosystem recently decided to exempt part of banks’ excess liquidity holdings from the negative deposit facility rate. Until the end of this year, this move will reduce Austrian banks’ costs by some EUR 30 million.

External financing of Austrian nonfinancial corporations reached a post-crisis high in the first half of 2019. Amid low interest rates, debt accounted for the lion’s share, what with a marked increase in the issuance of bonds and continued strong lending by Austrian banks. The annual growth rate of Austrian banks’ loans to nonfinancial corporations came to 7.1% in September 2019, still carried largely by loans to real estate firms. In the first six months of this year, firms’ debt grew at a faster pace than their profits, which caused their risk-bearing capacity to deteriorate slightly.

For households, debt grew more strongly than income as well, but this dynamic was less pronounced. Housing loans continued to drive lending to households. The reduction of the high share of variable rate loans, which had been observable over the past few years, has come to a halt this year. While variable rate loans currently hold the promise of low interest payments, they are subject to heightened interest rate risks. Households’ overall exposure to foreign currency loans contracted further, but individual borrowers remain vulnerable to currency risk.

In the course of 2019, Austrian banks’ total assets have again risen above EUR 1 trillion. Net profits reached EUR 3.5 billion in the first half, which is somewhat below the corresponding figure in 2018, as cost-income ratios remain high and banks have resumed risk provisioning – ongoing consolidation efforts and the shrinking number of banks notwithstanding. Austrian banks’ subsidiaries in Central, Eastern and Southeastern Europe (CESEE) continued to record above-average profitability, even though their profits had contracted year on year. Both their business activities and profits remain heavily concentrated on just a few EU countries and Russia. On a positive note, high credit growth in Austria and abroad went hand in hand with increasing capitalization.

Residential property prices in Austria have continued to rise in 2019. In the third quarter of 2019, they increased by 5% year on year, with the OeNB’s fundamentals indicator for residential property prices in Austria pointing to an overvaluation of 14%. In September 2019, the Austrian Financial Market Stability Board (FMSB) therefore reviewed banks’ compliance with its quantitative guidance regarding sustainable lending standards. While the FMSB acknowledged banks’ efforts to lower the share of new loans with high loan-to-value ratios and excessively long loan maturities, it also concluded that the share of new lending with high debt service (in relation to borrowers’ income) remained at an elevated level. As the buoyancy of the Austrian real estate market could fuel a self-reinforcing credit-price spiral, the FMSB will continue to monitor systemic risks from real estate financing. In addition, banking supervisors will continue to call on banks to apply sustainable lending standards. In line with its financial stability mandate, the OeNB will carefully evaluate whether the conditions for activating macroprudential measures are met and whether a recommendation to the FMSB for pre-emptive activation is warranted.

Banks’ business outlook is mixed: accommodative monetary policy supports both credit demand and borrowers’ ability to pay, which has driven the share of nonperforming loans to historical lows. At the same time, continued trade tensions and geopolitical uncertainties have caused the euro area economy to slow down. The weaker outlook for growth and concerns about a buildup of asset price bubbles in certain market segments clearly warrant heightened supervisory attention. In light of these developments, banks should ensure that they have enough room for maneuver in the case of a potential downturn. Specifically, the OeNB recommends that banks take the following measures to strengthen financial stability:

• Apply sustainable lending standards (especially in real estate lending), both in Austria and in CESEE, and comply with the quantitative guidance issued by the Financial Market Stability Board.
• Improve the cost-income ratio to safeguard profitability even in a potential downturn.
• Sustainably ensure adequate capitalization, especially by appropriately balancing dividend payouts and internal capital generation, to offset potential risks from strong credit growth (especially in CESEE).
• Develop and apply adequate strategies to deal with challenges linked to new information technologies (e.g. new business models and cybersecurity).

The OeNB’s semiannual Financial Stability Report provides analyses of Austrian and international developments with an impact on financial stability and includes studies offering in-depth insights into specific topics related to financial stability.