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Income from maturity transformation, interest rate risk and hedging by Dutch banks

PhD ceremony:drs. R.F.D.D. Chaudron
When:April 03, 2023
Supervisors:prof. dr. J. (Jakob) de Haan, prof. dr. S. (Steven) Brakman
Where:Academy building RUG
Faculty:Economics and Business
Income from maturity transformation, interest rate risk and hedging
by Dutch banks

Banks make a significant part of their profits by paying less interest on deposits and savings accounts than they earn on loans. This difference in interest rates is, among others, compensation for the risk that the loan is not repaid. Another reason why the interest rates differ is the term to maturity. Savings are usually locked in for a couple of years, while a mortgage can run for decades. This is beneficial to banks since the short rate is usually lower than the long rate. After the Great Financial Crisis of 2007-2008, the difference between long and short rates fell to historically low levels for a long time. This research shows that, counter to what many feared, profitability of banks in the Netherlands did not deteriorate strongly. The part of profits that derives from the difference in maturities is relatively small. Other factors, such as the level of competition between banks, are much more important in determining profits.

Banks also run substantial risks if the maturities differ significantly. When central banks increase short-term interest rates to combat inflation, the short rate can rise above the long rate, which is unfavourable to banks. These interest rate risks can even, when they are  mismanaged, lead to a banking crisis, as in the United States in the 1980s. Dutch banks limit these risks with the help of financial derivatives. One example is the interest rate swap, through which they exchange long rates for short rates, thereby lowering the difference in maturity artificially.