Credit impact will typically be moderately credit-negative for banks, non-bank financial institutions (NBFIs) and insurers – but less significant for funds
Fitch Ratings-London-08 December 2020: Longstanding ultra-low interest rates in major developed markets are likely to persist for even longer due to economic weaknesses after the coronavirus pandemic, with lasting effects on financial institutions globally, Fitch Ratings says. The credit impact will typically be moderately credit-negative for banks, non-bank financial institutions (NBFIs) and insurers – but less significant for funds. The possible rating impacts are beyond our typical two-year rating horizon and therefore do not affect current ratings or outlooks.
Net interest margins (NIMs) for banks in developed markets may be squeezed by low interest rates long after the pandemic. The profitability of large diversified banks is partly shielded by fee-based revenue from capital markets activity, which is less affected by interest rates. However, smaller, less diversified banks may struggle to remain profitable without taking extra risk, such as lending to riskier segments or over a longer duration. Pressure on profitability is likely to drive cost-cutting and could catalyze industry consolidation in some markets.
Banks in emerging markets may face similar margin compression due to lower local interest rates, which could be exacerbated by increased competition from developed market banks engaging in cross-border lending in search of higher margins than those in their own jurisdictions.
NBFI & Insurance Sectors
In the NBFI sector, developed market-based finance and leasing companies will be most affected by lower-for-longer interest rates, due to NIM compression. Retail brokers with NIM exposure will be more affected than other securities firms. The impact on financial market infrastructures should be limited, but international central securities depositories – and US-based trust and processing banks – could be more affected.
For the insurance sector, the biggest impact of low interest rates is on long-tail life business lines, where insurers have little or no ability to reprice contracts. Lower investment returns reduce life insurers’ ability to meet investment guarantees, pushing up reserve requirements and weakening earnings and capital.
Japan’s insurance market may become a blueprint for how insurers elsewhere will counter the effects of low rates. Life insurers in Japan have been affected by ultra-low interest rates for much longer than their global peers, and have mitigated the effects by adopting various product, investment and business strategies.
Fixed-income and money market funds face pressure on yields and assets under management from low interest rates. Conversely, private equity collateralized fund obligations may benefit as low rates keep financing costs for underlying companies low and support higher valuations.