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The European Central Bank says banks under its jurisdiction appear well-prepared to face unexpectedly higher interest rates, but may be less ready for disruption from online banking.

The ECB’s banking supervision division released results Monday of a stress test that showed suddenly rising rates would increase net interest income, an important part of bank finances.

Earnings at some banks have lagged due to the current very low interest rate environment that squeezes the margins between rates at which banks borrow and their lending rates.

Read: From the loonie to the euro: currency update

The central bank says that in a hypothetical interest rate shock involving an increase of 2 percentage points, net interest income would increase by 4.1% this year and 10.5% next. The stress test imagined a sudden overnight increase. That is a highly unlikely scenario, but one that helps show whether bank finances are robust.

The ECB concludes “interest rate risk is well managed by most European banks.”

It warns, however, that many banks are relying on questionable models to predict how their deposit customers might behave. The models were mostly constructed based on the years since 2008, which means they’re based on experience from a period of falling rates. Deposits are usually one of the most stable sources of money for banks, and a sudden decision by lots of people to take their money elsewhere could hurt bank finances. That could happen if people chase higher rates elsewhere, or get better offers for banking services from so-called fintech firms that use mobile banking, peer-to-peer lending or financial advice dispensed by software. The ECB says it would engage banks in discussion about their models.

Read: ECB holds key rate, cuts inflation forecast

The study shows that banks would show losses in the long-term value of their assets, such as investments in bonds and their mortgage business.

The ECB’s bank supervision division is kept separate from its monetary policy duties, so the stress test doesn’t provide any hints about the bank’s thinking on the future course of its rate policy.

Currently, the bank is contemplating phasing out its stimulus program over the course of next year. The bank has been buying 60 billion euros ($70 billion) of bonds a month in the hope of keeping market interest rates low, thereby helping to stimulate the economy and get inflation up to its goal of just under 2%. The bank has said it does not plan to raise its benchmark interest rate from the current zero until well after the bond purchases end, which would mean not until 2019 at the earliest.

Originally published on Advisor.ca
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