Low interest rates can pose safety-and-soundness issues, state bank regulator says
By Ted Knutson
WASHINGTON, July 19 (Thomson Reuters Accelus) – The low interest rate environment being pushed by the Federal Reserve can pose safety and soundness issues for some banks, Michael Stevens, senior executive vice president of the Conference of State Bank Supervisors, told Thomson Reuters Accelus Wednesday.
“Low interest rates are a supervisory concern because they can have a corrosive effect on net interest margins, which impacts profitability, which impacts capital formation, which affects the ability to lend more and to grow,” said Stevens.Reduced interest margins can be a safety and soundness problem for banks that don’t manage them well, Stevens added.
An issue on an uncertain horizon for banks and their overseers will be when interest rates inevitably rise, Stevens noted, saying that is a situation no one in the banking industry has faced before.
Banks can protect themselves by ensuring long-term cheap funding – one way is to persuade depositors to buy longer term certificates of deposit, by taking the caps off adjustable rate mortgages and by accumulating short term assets so higher rate assets can be obtained when interest levels increase, Stevens said.
But Stevens warned that the strategy is hard to implement with attractive long term and short term results, saying, “It’s a challenge to have a balance sheet structure that is profitable today that allows you to take advantage of rising rates in the future.”
It’s encouraging from a regulatory perspective that farmland purchases spurred by rising commodity prices are being done largely with cash rather than debt, said Stevens.
“What we want to see greater appreciation of risk out there, that debt doesn’t materially increase and that underwriting standards don’t decrease. That what will help us navigate this issue,” Stevens said.
Stevens also warned against a euphoria that values will always go up, an illusion that helped the housing market fuel the recession.
Despite worries that when commercial mortgages came up for renewal en masse they could lead to another economic downturn, Stevens said banks are handling them well, saying, “The economy is stable, values have stabilized and bank capital is stronger.”
Commercial mortgage risks are easier for small banks to manage than construction loans because the lenders have earning assets to restructure against, Stevens said. When income is down for a commercial property up for renewal, a bank can make a concession on the interest rate or make a loan above the customary loan to appraised value ratio.
“Community bankers know how to do this because they know the customers, they know the market [and] they know the property – unlike the servicers for home loans [who] didn’t know how to deal with restructuring,” Stevens noted.
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