Private debt levels are high in the Netherlands and the euro area. In 2017, household debt in the Netherlands amounted to 107% of GDP and NFC debt to 113% of GDP. Compared with the euro, debt levels in the Netherlands are high (households: 58%, NFCs: 83%). When interest rates increase in the future, it remains to be seen what the impact will be on the sustainability of private debt.
The impact of rising interest rates
An increase of market interest rates will not immediately impact the average rates payable by households and corporations, since these average rates depend on various factors, including maturity and individual interest rate agreements. We have accounted for these factors in our underlying analysis by looking at the average interest rates paid. Our analysis shows that it takes seven quarters for an increase of short-term interest rates by 25 basis points (bps) to be almost fully incorporated in the average rate for NFCs. The effect is smaller for households, since these rates are generally fixed for longer periods.
To gain an understanding of the private debt burden, the Bank for International Settlements (BIS) calculates the repayment capacity for these debts using debt service ratios (DSRs), which measure the ratio between total debt payments (repayments plus interest) and the gross disposable income of the sector. The higher these ratios, the lower the repayment capacity – and the more significant the impact of interest rate increases. Our analysis is based on the BIS method and simulates the impact of a 200 bps increase in short-term interest rates over a two-year period. We have chosen this extreme and fictitious scenario to assess the full potential impact of substantially altered financial conditions. We also assume that the debt/income ratio remains unchanged in the future, which means all DSR movements are caused by interest rate changes.
Corporations in particular are vulnerable to rising interest rates.
Our calculations show that in particular DSRs for NFCs will approach the levels observed during the crisis (Figure 1a). In the euro area, the euro crisis level (2012) will be reached in 2021. In the Netherlands, DSRs increase more slowly, and will remain below the peak levels observed during the first years of this century. However, the recent decline will largely reverse.