Global financial crisis WARNING: ECB stress test exposes HUGE RISK to Europe’s banks

A ‘stress test’ carried out by the central European bank on the most important European institutions has revealed that they may not be able to cope with the anticipated rise in interest rates across the continent.

A total of 111 financial institutions took part in the test, with 51 discovered to have potential problems and are not sufficiently prepared.

The ECB wanted to check how well the banks are prepared for a sudden interest rate hike in monetary policy.

ECB Director General Korbinian Ibel said: ”Overnight the banks will wake up and have a new interest rate environment. What would happen if the new environment were to last forever?”

On the surface, higher interest rates are positive for all the banks, making investments more attractive due to the higher returns and similarly, a higher return on their loans.

According to the ECB’s calculations an interest rate increase of two percentage points, would raise income from interest rates by almost eleven per cent by 2019.

However the ECB has warned that the value of the papers that banks still hold in the books is shrinking.

Because most of them bought them when the interest rates were significantly lower. The prices of the securities therefore fall with an increase in interest rates, and their returns are considerably losing attractiveness.

Old loans also lose value. With an increase in interest rates of two per cent, the value of the investment portfolio would therefore shrink by 2.7 per cent.

However, most of the eurozone financial centres would be able to deal with it.

Mr Ibel said: “The results show that, on average, banks are prepared to cope with changes in interest rates.”

However not all of them would. Some base their planning too much on the current low interest rates, their internal models for the future development do not take into account a possible rise enough.

In total, 51 institutes need to fear talks with the supervisory authority. They are not well prepared for an increase in interest rates, and many of them will probably need more capital to cushion possible losses.

Another result of the test, an extension of the mini interest rate era would be a huge burden for all banks, the interest rate income would shrink by 7.5 per cent.

The ECB has kept its policy rate extremely low for a long time and is now at zero per cent.

Banks also have to pay a penalty if they park money at the ECB overnight. The deposit rate is minus 0.4 percent.

Since autumn 2014, the ECB has been responsible for overseeing the major banks in the eurozone. It now controls 120 institutes – including Deutsche Bank and Commerzbank.

The German Central Bank and the financial supervisory authority BaFin had recently examined how the approximately 1,500 smaller German institutes and savings banks are able to cope with the current low interest rate.

According to the results, the financial institutions are better able to cope with this than they did years ago.

Nevertheless, they will also be suffering from low interest rates in the coming years. The institutes had indicated that their profit before tax would shrink by 16 per cent over five years, as measured by their balance sheet total.

Additional reporting by Monika Pallenberg.