Rising Interest Rates and Inflation: What Impact on Banks?
Following the pandemic, geopolitical developments and the energy crisis are placing further pressure on financial and credit markets. As inflation continues to rise, interest rates are also increasing. Banks must therefore exercise greater vigilance when granting loans to their clients.
This situation will significantly affect future lending, as well as variable-rate and mixed-rate loans entered into before the interest rate increases at the beginning of the year.
It should be recalled that a variable interest rate fluctuates according to various factors and, where applicable, within certain limits. It must be determinable by reference to factors beyond the lender’s control, failing which the relevant provision may be declared null and void.
It should also be noted that the margin applied by a bank when granting a loan may either remain fixed throughout the loan term or vary, for example according to the borrower’s creditworthiness or risk profile, as measured by a specific financial ratio or credit rating.
Where the margin is variable, it must likewise be determinable by reference to objective criteria.
What Is Driving Inflation?
The inflationary environment at the time of writing was partly attributable to the ongoing pandemic, which continued to disrupt global supply chains, particularly in China, even as economies elsewhere reopened.
The invasion of Ukraine in February 2022 accelerated inflation, notably because some European countries had poorly managed their energy mix in previous years, while many others depended on Ukrainian grain exports.
This inflation has led to a significant increase in interest rates, and further increases are expected.
Inflation: The ECB’s New Priority
“The European Central Bank (ECB) is responsible for maintaining monetary stability in Europe. As such, it has all the necessary tools to ensure price stability within the European Union.
In this context, it recently decided to end its quantitative easing programme and progressively increase most of its key interest rates by 25 basis points in July, followed by a further increase in September, depending on updated medium-term inflation forecasts.
The ECB’s objective is to bring inflation back towards 2% over the medium term,” explains Nicolas Antoine, Senior Associate at Brucher Thieltgen & Partners.
By taking these measures, the ECB seeks to discourage borrowing and encourage saving, thereby slowing economic activity and, consequently, reducing inflation.
This means that upward pressure on interest rates is likely to intensify in the months ahead, placing additional strain on the financing capacity of households, businesses and governments alike.
Increased Vigilance Required from Banks
During this period of significant change, financial institutions must exercise heightened vigilance to minimise litigation risks and avoid unnecessary financial losses.
The risk of payment defaults has increased. While some individuals may benefit from salary increases, others are experiencing stagnant incomes alongside rising monthly expenses, despite reducing their consumption.
Banks would therefore be well advised to assess whether certain loans are excessive or disproportionate to their clients’ repayment capacity and to review the guarantees securing those loans.
This would enable them to address potential difficulties at an early stage, as soon as the first missed payment occurs, and explore possible solutions with the client.
If they have not already done so, banks should also ensure that their loan agreements and related documentation are up to date and that the files of existing clients are complete.
Furthermore, given that financial markets are being affected both by the ECB’s decision to end its accommodative monetary policy and by the prevailing geopolitical instability, particular attention should also be paid to products such as Lombard loans.
“With regard to this type of financing, banks must ensure that clients are properly informed about current market conditions and that contractual deadlines relating to margin calls are strictly respected. There is already a substantial body of case law on this matter.”
Nicolas de Jonghe d’Ardoye, Counsel : nicolas.dejonghe@btplawyers.lu