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Rising interest rates and higher inflation: implications for the banking sector

Author

Listed:
  • Morell, Joe

    (Central Bank of Ireland)

  • Shaw, Frances

    (Central Bank of Ireland)

  • Lyons, Paul

    (Central Bank of Ireland)

  • McCann, Fergal

    (Central Bank of Ireland)

Abstract

While higher inflation and higher interest rates are likely to bring downside economic risks to many economic sectors, the outlook is more balanced for the banking sector. In this Note we outline the various channels through which higher inflation and higher interest rates can both benefit and challenge the banking sector, with an empirical focus on Ireland. We conclude that, in the absence of a wider economic recession, benefits are likely to accrue to the Irish retail banking sector on net, primarily through banks’ role in maturity transformation which is likely to lead to improving interest margins. While there is uncertainty around the path for loan impairments and provisioning, in a stress testing exercise, we show that adverse scenarios in which interest rates remain elevated lead to less severe outcomes for banks than scenarios where downturns are combined with low interest rates.

Suggested Citation

  • Morell, Joe & Shaw, Frances & Lyons, Paul & McCann, Fergal, 2022. "Rising interest rates and higher inflation: implications for the banking sector," Financial Stability Notes 15/FS/22, Central Bank of Ireland.
    • Handle: RePEc:cbi:fsnote:15/fs/22
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    References listed on IDEAS

    as
    1. Altavilla, Carlo & Canova, Fabio & Ciccarelli, Matteo, 2020. "Mending the broken link: Heterogeneous bank lending rates and monetary policy pass-through," Journal of Monetary Economics, Elsevier, vol. 110(C), pages 81-98.
    2. Kelly, Robert & Byrne, David, 2019. "Bank asset quality and monetary policy pass-through," ESRB Working Paper Series 98, European Systemic Risk Board.
    3. David Byrne & Robert Kelly, 2019. "Bank asset quality & monetary policy pass-through," Applied Economics, Taylor & Francis Journals, vol. 51(23), pages 2501-2521, May.
    4. Holton, Sarah & d’Acri, Costanza Rodriguez, 2015. "Jagged cliffs and stumbling blocks: interest rate pass-through fragmentation during the Euro area crisis," Working Paper Series 1850, European Central Bank.
    5. Holton, Sarah & Rodriguez d’Acri, Costanza, 2015. "Jagged Cliffs and Stumbling Blocks: Interest Rate Pass-through Fragmentation during the Euro Area Crisis," Research Technical Papers 01/RT/15, Central Bank of Ireland.
    6. Matthias Doepke & Martin Schneider, 2006. "Inflation and the Redistribution of Nominal Wealth," Journal of Political Economy, University of Chicago Press, vol. 114(6), pages 1069-1097, December.
    7. Gambacorta, Leonardo, 2008. "How do banks set interest rates?," European Economic Review, Elsevier, vol. 52(5), pages 792-819, July.
    8. Khan, Mohsin S. & Senhadji, Abdelhak S. & Smith, Bruce D., 2006. "Inflation And Financial Depth," Macroeconomic Dynamics, Cambridge University Press, vol. 10(2), pages 165-182, April.
    9. Adhikari, Tamanna, 2022. "Inflation and mortgage repayments: the household expenditure channel," Financial Stability Notes 6/FS/22, Central Bank of Ireland.
    10. Boyd, John H. & Levine, Ross & Smith, Bruce D., 2001. "The impact of inflation on financial sector performance," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 221-248, April.
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    Cited by:

    1. Adhikari, Tamanna & McGeever, Niall, 2023. "How resilient are Irish SMEs to input cost inflation?," Financial Stability Notes 6/FS/23, Central Bank of Ireland.
    2. Gaston Giordana & Michael H. Ziegelmeyer, 2023. "Household indebtedness and their vulnerability to rising interest rates," BCL working papers 173, Central Bank of Luxembourg.

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