The turnaround in interest rates has struck. It causes banks to wobble and raise new concerns about retirement provision. And construction almost comes to a standstill. Financing is regarded as the fuel of the real estate industry. This machine is now running sluggishly. In addition to the interest rate turnaround, banks are demanding more equity capital and providing less financing. Projects are delayed or cancelled. In the real estate industry, it is exemplary to observe what happens on the markets when interest rates change very quickly. The interest rate risk, in the long phase of falling interest rates only a theoretical variable, has a full impact. The collapse of Silicon Valley Bank, which had to sell government bonds far below the purchase price after a withdrawal of investors, is only the most severe example so far.
Jan Hauser
Editor in business.
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Philipp Krohn
Editor in the economy, responsible for "People and Economy".
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Hanno Mußler
Editor in business.
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In September, the Bank of England, which was only marginally perceived in this country, had to launch a program of 65 billion pounds to stabilize the British pension system. Pension funds had to raise liquidity because derivatives with which they had protected themselves against the low interest rate suddenly lost value. The trigger was thoughtless statements by the soon-to-be-resigned Prime Minister Liz Truss on tax cuts. The nervousness was palpable.
Increased vulnerability
Banks and insurers, the powerful sectors of the financial sector, had warned that after years of loose monetary policy, an abrupt rise in interest rates could be necessary to control inflation. A slow exit from unconventional bond purchases and ultra-low interest rates would be better. Now the fears are confirmed. "Even highly liquid government bonds are not safe, which falls on the feet of some banks because they have a price risk," says Hans-Peter Burghof, Professor of Banking at the University of Hohenheim.
The rise in interest rates since the beginning of 2022 is one of the steepest in history – regardless of whether it started a little earlier, as in the US, or later, as in the euro area. When financial service providers hold bonds, this leads to losses in value that are sometimes more serious, sometimes lighter. "Due to the high speed of the correction of monetary policy, we are in a phase of increased vulnerability," says Burghof. "But it only becomes effective when liquidity is lacking." This problem has brought down Silicon Valley Bank. It had to compensate for a lack of liquidity by selling bonds – losses in value were realised. If it had been able to hold securities to maturity, losses would have been compensated.
Interest rate risk is more relevant for banks than for insurers. Although both hold bonds, banks convert short-term deposits into long-term loans and investments via maturity transformation. Life insurers have less liquidity requirements due to regular premium income and can usually hold securities until maturity because they do not have to make a payment until the end of the contract term.