A long period of low interest rates could impact the health of banks, insurance companies and private pension funds, and, in turn, pose risks to financial stability, concludes a report published Thursday from the Committee on the Global Financial System (CGFS).
“For banks, low rates might reduce resilience by lowering profitability, and thus the ability of banks to replenish capital after a negative shock, and by encouraging risk-taking,” the report states.
For insurance companies and pension funds, falling rates cause the present value of liabilities to rise more than the present value of assets, affecting solvency.
“In addition, the scope for claimholders to terminate life insurance contracts early can become a source of liquidity vulnerability for insurance companies if a period of low interest rates ends with a sudden snapback in rates,” the report states.
The report warns that a sudden increase in rates from 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,” says Philip Lowe, chair of the CGFS and governor of the Reserve Bank of Australia, in a statement.
“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,” he adds.