Macroprudential Policy Issues Arising From Low Interest Rates And Structural Changes In The EU Financial System.pdf

The current macro-financial environment is characterized by exceptionally low, and even negative, nominal interest rates, which can have both a positive and a negative impact on the financial system and the economy. This report discusses the sources, implications, and potential vulnerabilities and risks for the EU financial system deriving from the low interest rate environment and ongoing structural changes in the financial system. The analysis considers two possible scenarios for future nominal interest rate trends over the next ten years: a protracted low interest rate environment accompanied by low growth (“low for long”) and an economic recovery scenario under which interest rates rise gradually (“back to normal”). The main findings include:

1. The main financial stability risks identified in the prolonged low interest rate environment relate to profitability pressures and weakening resilience in some sectors of the financial system, broad-based risk-taking affecting financial markets, as well as risks associated with an accelerated transition to a more market-based structure.
2. The protracted low interest rate environment puts pressure on the profitability and solvency of financial institutions that provide longer-term return guarantees, i.e. guaranteed-return life insurers and defined-benefit pension funds.
3. The low interest rate environment is also weakening the resilience of some financial institutions, particularly those with longer-term return guarantees, and is leading to broad-based risk-taking in financial markets.

The report proposes a holistic macroprudential policy approach aimed at enhancing financial stability and mitigating systemic risks in the low interest rate environment.