Interest rate risk exposures of non-financial corporates and households

Implications for monetary policy transmission and financial stability

The exposure of non-financial corporates (NFCs) and households to interest rate risk directly affects the transmission of monetary policy to aggregate demand and influences borrowers' creditworthiness. Interest rate risk in the private non-financial sector is the risk that market interest rates affect financial incomes, asset prices and debt servicing burdens. Understanding the implications of exposure to interest rate risk is important to central banks not least because monetary policy transmission is an essential element of inflation control and the evolution of borrowers' creditworthiness affects financial stability.

Against this backdrop, the CGFS report analyses 23 advanced and 26 emerging market economies. First, it adopts a historical perspective in investigating the sensitivity of NFCs' investment and households' consumption as well as the financial resilience of the private non-financial sector to policy rate hikes. Second, it compares the experience over the first six quarters of the latest tightening cycle to historical regularities.

Among the key findings:

• While borrowing rates rise quickly after the start of monetary policy rate hikes, declines in aggregate demand and signs of financial stress take longer to materialise.
• Historically, policy rate hikes have tended to reduce aggregate demand but also usher in financial stress if implemented when a joint credit and asset price boom coexists with adverse supply shocks.
• Over the first six quarters of the latest tightening cycle, aggregate consumption and investment evolved similarly to the historical norm or held up better. In parallel, households and NFCs appeared generally resilient.

The more recent experience is consistent with many households and NFCs insulating themselves from interest rate risk during the low-for-long interest rate era – albeit to varying degrees, depending on income and size, respectively. The findings could also reflect successful pandemic-related support measures and targeted prudential policies.

The report does not draw definitive policy conclusions. For one, the focus on policy rate hikes and their effects on households and NFCs through borrowing costs may not capture the full extent of a monetary policy tightening. Another reason is that the overall effect of monetary policy tightening tends to surface with a long lag.