Ongoing profitability pressure creates an incentive for banks to step up their exposure to interest rate risk and adopt an imprudent attitude in their affordability assessments. Equally, banks may react to earnings pressure by expanding the volume of credit. Together, such developments would cause prices on the Swiss real estate market to gain momentum again, following a recently slowdown. This is particularly relevant given that real estate remains relatively attractive, not just to households but to investors searching for yield. The net result of this would be a renewed rise in imbalances on the real estate and credit markets. This would make borrowers and banks more vulnerable – to an unexpected future interest rate rise, for instance. In particular, it would increase the magnitude and overall economic impact of a price correction on the real estate market. In the spirit of a cautious, forward-looking approach, it is essential given the current interest rate environment that banks apply conservative principles in their lending activities. This is particularly necessary when it comes to assessing the sustainability of loans. Based on experience from the crisis in the 1990s, banks now typically assume an interest rate of 5% when assessing affordability risk; this is the approximate historical average of long-term mortgage interest rates.
At a time when we are witnessing an increase in corporate nonperforming loans, I reiterate my call for the banks to expand their provisions commensurately with this heightened credit risk. At the same time, dividend policies must be mindful of the need for higher levels of retained earnings in order to further strengthen capital buffers, also in view of the more onerous requirements of Basel III. Finally, I would encourage risk officers to go beyond simple compliance with regulations and proactively espouse prudent risk management practices and good judgement. BIS central bankers’ speeches  3  Before I hand over the floor to Professor Bannister, I would like, on this my last official meeting with the financial community, to express my sincere appreciation to you all for the cooperation and understanding I have benefited from over the past twelve years. Thank you. 4  BIS central bankers’ speeches