Adjustable-rate mortgages in the era of global reflation: How to model additional default risk?

Abstract

We investigate the problem of interest rate risk transforming into default risk of adjustable-rate mortgage loans in the EU. Bank regulation is strikingly not neutral in this aspect, it explicitly favors short-duration adjustable-rate loans over long-duration fixed-rate loans in the framework of the gap management. This asymmetry in the regulation creates perverse incentives both for banks and households, which can lead to aggressive risk-taking, over-indebtedness of unhedged households, high procyclicality of mortgage markets, and increased systemic risks. We present a stress test model to quantify potential losses stemming from this specific risk from the perspective of lender institutions. We estimate the average extra capital that is needed to cover the additional risk of adjustable-rate mortgage loans in the EU to be 0.53% of the value of the total mortgage portfolio and 1.97% of the value of the adjustable-rate mortgage portfolio. We propose introducing a stress test model as a new mandatory element into banks’ risk management framework.

Does prudential capital reduce bank risk-taking? Empirical evidence from the Indonesian banks industry

“…This analysis uses the pace of Indonesian GDP growth and the rate of inflation macroeconomic control variables. GDP denotes a variation in economic activity during the business cycle, which most likely influences the performance of a country's financial institutions Abbas, Masood, et al, 2021;Anginer et al, 2021;Banai et al, 2022;Conti et al, 2022;Ginting & Widyawati, 2022;Zhang et al, 2018). The consumer price index will be utilized as a stand-in for the inflation rate in this study.…”