Policy rate hikes raise loan loss rates by 0.1 percentage points

A new Bank for International Settlements (BIS) working paper investigates how monetary policy interest rates influence credit loss rates.

Using annual data from 113 countries over three decades, the study applies local projections to find that a 1 percentage point increase in policy rates typically raises loan loss rates by 0.1 percentage points.

This effect is economically significant, particularly in advanced economies where it is relatively larger than in emerging market economies.

The researchers confirm these rule-of-thumb estimates through various methodologies, including instrumental-variable estimation and bank-level data, ensuring their robustness across different analytical approaches.

The paper highlights that the impact of rate hikes on credit losses is strongly state-dependent, intensifying under specific macro-financial conditions.

These include a loose pre-tightening monetary policy, high private debt levels, contractionary fiscal policy, an economic downturn, and simultaneous central bank balance sheet reduction.

Banks with riskier loan portfolios before tightening also experience larger increases in credit losses.

The findings underscore the need for central banks and prudential authorities to integrate credit-risk dynamics into macroprudential and stress-testing frameworks to safeguard financial stability.