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

Joe Morell, Frances Shaw, Paul Lyons and Fergal McCann
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Frances Shaw: Central Bank of Ireland
Paul Lyons: Central Bank of Ireland
Fergal McCann: Central Bank of Ireland

No 15/FS/22, Financial Stability Notes from 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.

Date: 2022-11
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