Repricing of bank assets and liabilities in the current rate hike cycle: historical perspective and impact on bank profitability

After several years of low or even negative interest rates, rates have been rising since mid- 2022. While banks in Austria had been unable to pass negative interest rates on to retail deposits because they were legally required to keep these rates above 0%, the Austrian banking sector benefited from the current rate hike cycle, with banks reporting high profitability levels. Deposit margins have increased since mid-2022, as have various credit spreads (i.e. the difference between lending and deposit rates). Furthermore, banks’ high profitability is also driven by historically low credit risk costs. The average overnight deposit rate in Austria (0.69% in July 2023) is higher than the euro area average of 0.27%. For loans, and in particular for consumer loans, however, both the interest rate level and pass-through rate are also higher in Austria. This is attributable, inter alia, to the combined effect of a higher share of variable rate loans and an inverted yield curve. In sum, Austrian banks’ credit spreads increased faster in the current rate hike cycle than those of banks in other euro area countries. We find low cumulative betas (i.e. the pass-through of a reference rate to the deposit rate) for overnight deposits (16% for households in the current rate hike cycle) and higher betas for new term deposits (up to 88% for nonfinancial corporations and 65% for households). A main reason for the historically low betas observed in the current cycle is the excess liquidity in the market. Finally, we find that interest rates are passed on to deposits more slowly in times of increasing interest rates than in times of declining interest rates. After the onset of the global financial crisis and during the low interest rate environment prevailing until mid-2022, euro area banks’ cost of equity was consistently higher than their return on equity. Bank profitability increased in the current rate hike cycle, and in light of macroeconomic uncertainties and potentially rising credit risk costs, banks should use profits to further strengthen their capital position.