Monday, June 28, 2010

Bankers beware

"... Low policy rates in combination with higher long-term rates increase the profits that banks can earn from maturity transformation, ie by borrowing short-term and lending long-term. Indeed, part of the motivation of central banks in lowering policy rates was to enable battered financial institutions to raise such profits and thereby build up capital. The heightened attractiveness of maturity transformation since the crisis was reflected in rising carry-to-risk ratios in 2009 and early 2010 (Graph II.1, bottom right-hand panel). Increasing government bond yields, caused by ballooning deficits and debt levels and a growing awareness of the associated risks, make the yield curve even steeper and reinforce the appeal of maturity transformation strategies.
However, financial institutions may underestimate the risk associated with this maturity exposure and overinvest in long-term assets.5 As already noted, interest rate exposures of banks as measured by VaRs remain high. If an
unexpected rise in policy rates triggers a similar increase in bond yields, the resulting fall in bond prices would impose considerable losses on banks. As a consequence, they might face difficulties rolling over their short-term debt..."
BIS annual report 2010, p. 41

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