Open AccessAdjustable-rate mortgages in the era of global reflation: How to model additional default risk?
Author(s) -
Ádám Banai,
Edina Berlinger,
Barbara Dömötör
Publication year - 2022
Publication title -
plos one
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.99
H-Index - 332
ISSN - 1932-6203
DOI - 10.1371/journal.pone.0263599
Subject(s) - portfolio , stress test , interest rate , monetary economics , mortgage underwriting , systemic risk , economics , interest rate risk , default risk , risk management , business , credit risk , financial economics , actuarial science , financial crisis , mortgage insurance , finance , macroeconomics , casualty insurance , insurance policy
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.