Box 3: Implications of rising interest rates for borrowers and the real estate sector

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Financial Stability Report 2022 BEGINNING OF THE CHAPTER TABLE OF CONTENT

BOX 3 Implications of rising interest rates for

borrowers and the real estate sector

The risks in the real estate and mortgage market have increasingly come into focus against the backdrop of the sharp rise in interest rates. Higher mortgage interest rates imply a higher debt servicing burden for borrowers who have taken out loans with

variable interest rates or whose mortgages are newly negotiated. This could be a challenge especially for low-income households, in particular in those countries where household debt is elevated. As pointed out repeatedly in recent years, the affordability of mortgage loans for households does indeed represent a vulnerability in Liechtenstein, with any further surge in household indebtedness going hand in hand with an additional increase in systemic risks.

In Liechtenstein, several risk-mitigating factors decrease the acute vulnerabilities related to the

current interest rate increase. On the one hand, avail-

able data indicate that real estate prices in Liechtenstein have developed less dynamically in recent years compared to other European countries, and that the overvaluation is therefore likely to remain contained. On the other hand, before granting loans, Liechtenstein banks conduct an affordability analysis with an imputed interest rate – in practice of around 4.5 % –whereby the resulting debt service burden should not exceed a certain share of household income in this

scenario. This affordability analysis already considers a hypothetical interest rate increase to 4.5 %, which means that the loans in such a scenario should, at least

in principle, remain affordable for households. However, it should be noted that the proportion of loans secured by mortgages in Liechtenstein that represent an exception to these (bank-internal) guidelines is relatively high at around 21 % of the total mortgage lending volume as of June-2022.7 In addition, despite the significant increase in recent months, a rise in interest rates to

more than 4.5 % seems relatively unlikely at present in the Swiss franc currency area. Another risk-mitigating factor in the short run is the large proportion of mortgage loans that are concluded with a fixed interest rate. This development greatly mitigates the immediate effects of the surge in interest rates, as the recent climb of interest rates only gradually affects households (and thus the real estate market) in Liechtenstein.

Finally, the resilient labour market and, on an aggregate level, the relatively high household wealth also lead to a mitigation of risks associated with the rise in interest rates (see the previous section for an overview of risk-mitigating factors in the domestic RRE market).

Even in the case of a real estate crisis, the threat of contagion within the economy would be significantly less pronounced than in other countries. Procyclical effects of a downturn in the financial cycle would be significantly lower in small and open economies like Liechtenstein, as domestic demand does not play a major role. Hence, even a significant increase in the savings rate of private households would have only negligible demand effects and would limit the impact on the overall economy. Negative contagion effects within the banking sector also seem unlikely in the current environment, as banks’ business models focus

primarily on other sources of income and their capitalisation is above the European banking sectors’ average. In summary, an abrupt rise in interest rates leads to higher interest and debt service payments on mortgages, thereby also increasing the credit risk for banks. While the overall economy would probably be less affected in Liechtenstein than in other countries in

the case of a real estate crisis, addressing mediumterm risks is still central to ensure financial stability in the medium to long term.

7 So far, the respective guidelines are only qualitatively defined in the Banking Ordinance, i.e. the quantitative criteria defining affordability differ substantially across banks. A revision (and harmonisation) of the guidelines is currently discussed.

MACROFINANCIAL ENVIRONMENT Financial Stability Report 2022 33