Examining the Relationship Between Interest Rates and Bank Risk-Taking: Evidence from the EU’s Largest Banks

Abstract

This study examines how interest rate affects the risk of banks and whether banks are more profitable in ROA terms during times with relatively higher interest rates. To be able to investigate this, data from 20 banks were collected from 2006-2023 on a quarterly basis and various control variables as well. The banks are the 20 largest ranked on assets on the balance sheet within the European union and consist of nine different countries. The control variable of interest was the interest rate from the central bank, additional 4 control variables were added. The data was then used for regression, the regression to the risk level of banks were runned 5 times each time with an additional control variable of interest. Also, regressions were runned for each country to be able to see differences and similarities between countries. A separate regression was runned to see the profitability for the banks. The findings from the regression was significant, that as the interest rate increases banks become more risky, this could be seen both when testing over the whole sample but also country wise. At the same time could it be seen that banks are more profitable during times with relatively higher interest rates.