Press release: Interest rate increase due to rising risk premiums pose a risk

Press release
Date 1 June 2018

One of the main risks to financial stability is a sudden increase in interest rates due to rising risk premiums. Risk premiums may increase as a result of political unrest, as currently seen in Italy, but also in response to an escalating trade war or rising geopolitical tensions. This emerges from DNB's Spring 2018 Financial Stability Report (FSR) published today. The report will serve as DNB's input for the annual public meeting of the standing parliamentary committee for Finance, the president of DNB, and the executive director of the Netherlands Bureau for Economic Policy Analysis to discuss macroeconomic risks to the financial system. The meeting will be held on Wednesday 6 June.

Risk posed by sudden rise in interest rates

Recent developments in Italy show that interest rates can suddenly rise sharply when risk premiums increase amidst political unrest. If this trend continues, it may threaten financial stability. Sharply increasing interest rates may severely hit heavily indebted households, corporations and governments. A sudden increase in interest rates may also cause financial institutions to be faced with heavy losses on their investment portfolios. Furthermore, in countries where the government relies heavily on its own banking sector to fund its debt, as in Southern Europe, the banking sector will suffer severe losses if risk premiums on government paper suddenly jump.

Interest rate increase will hit corporations sooner than households

As Dutch corporations often use more short-term funding than households, they will experience the consequences of rising interest rates sooner than households. Households have reduced their vulnerability to interest rate hikes over the past years by making more redemption payments on their mortgage loans and by increasingly opting for longer fixed interest periods when taking out a mortgage. The effects of a rise in interest rates differ widely between households and between corporations. Vulnerable corporations and households would do well to arm themselves against potential interest rate hikes by building up financial buffers.

Spill-over effects on the housing market

Meanwhile the Dutch economy is growing at full speed. In the major cities, where residential properties are increasingly being bought by private investors, house prices have already risen to well above their 2008 levels. A spill-over effect from the major cities is now being observed; prices in the surrounding regions are also rising substantially.

Despite the substantial increases in house prices, there are as yet no signs of a credit-driven bubble; home owners are making repayments on their mortgage loans, either voluntary or scheduled, and buyers are increasingly using savings to finance a home. However, if house prices continue to increase at the current pace, it is likely that mortgage lending growth regains momentum and financial stability risks increase. Moreover, borrowing criteria in the Netherlands are still very generous from an international perspective. In order to relieve the price pressure on the housing market, housing supply must be increased, especially in the middle segment of the rental market.

Risk map OFS