The interest rate turnaround has ended an exceptional market environment for banks. While higher interest rate levels are likely to be accompanied by some transitional difficulties in the short term.

Russia's attack on Ukraine, the energy crisis, record-high inflation and rising interest rates determined the environment banks found themselves in the past year.

The greatest threats arising from this environment, according to EY's Banking Barometer 2023,  include a global recession as well as geopolitical trouble spots coming to the fore, while global debt continues to be rated as very serious, and energy and stagflation have moved into the spotlight.

Pandemic Risks

On the other hand, some risk assessments and perceptions have weakened: Concerns around a stock market crash, a real estate crisis and even inflation are lower. Pandemic risks are hardly mentioned and even the implications of accelerated climate change have lost weight.

Inflation forced central banks to raise interest rates rapidly: «For banks, rapidly and sharply rising interest rates are a problem,» Managing Partner Patrick Schwaller said while presenting the results from the survey at a media event on Tuesday.

Turning Point

«They are able to manage continuously rising interest rates at a slow pace,» he said. The expected increase in loan defaults should be seen as a turning point on the way to normality in the Swiss banking business, Schaller said, adding that default risks as a part of the banking business.

Recalling that we are coming from a particularly low level of defaults due to the historically exceptional situation of negative interest rates in recent years along with government aid for companies during the pandemic, he said that a few more cases represent an increase, which is why about 60 percent of the banks are expecting higher defaults.

Rising Defaults

With regard to housing loans, 31 percent of the banks surveyed expect higher value adjustments in the next two years. 59 percent expect significantly higher loan loss provisions for SME loans in the short term. In the previous year, these figures were 12 and 36 percent, respectively.

Higher interest rates have other effects on real estate financing. «Banks are seeing a clear shift from fixed-rate to money market mortgages,» Schaller said. While rising credit risks cloud the short-term outlook, the longer-term expectation on margins is clearly positive.

High Volume

«Many banks have expanded lending volumes sharply in recent years and in 12 years it has increased by 60 percent. Now the high volume is hitting rising interest rates.» This is why it is not surprising that regional and cantonal banks in particular see the greatest growth potential in the lending business.

For private and foreign banks, the focus is on investment and trading business. The stock market slump caused losses in these areas in 2022.

Competition Driving Adjustments

«In the case of savings interest rates, normalization will separate the wheat from the chaff,» Schwaller said. Banks that tend to have problems meeting the rising liquidity requirements will have to pay higher interest rates. Others that do not have this problem will take their time in making adjustments.

But interest rates are not the only area where competition is at play. In many client relationships, individually negotiated special conditions are also being granted in lending and asset management, as Olaf Toepfer, Head of Banking & Capital Markets at EY said.

Special Conditions

However, due to the high volume of current business, changes will only take effect slowly. «Once special conditions have been granted, it is difficult to take them away again,» Toepfer added.

Competition can also be seen in fees. According to the survey, only two percent of banks said that they will be able to increase their fees, compared to seven percent last year.