Stagflation risks put bank Treasury and ALM teams in a squeeze: funding costs stay high while growth weakens and credit strains build. That combination can magnify IRRBB through deposit betas, optionality, and valuation shocks, while also raising liquidit
Stagflation is the risk scenario
bankers dread because it attacks both sides of the balance sheet at once.
Slow or contracting growth undermines
asset performance and loan demand, while inflation pressure keeps interest
rates elevated and volatile.
Markets have been alert to the
possibility for months, with investor surveys and commentary highlighting
concern that tariffs and supply-side shocks can keep prices sticky even as
growth cools.
For Treasury and ALM leaders, the
immediate challenge is that stagflation can amplify Interest Rate Risk in the
Banking Book. IRRBB is fundamentally the risk that adverse rate moves hurt
earnings and capital by changing the timing and present value of cash flows.
Global standards emphasize that
excessive IRRBB can threaten both current capital and future earnings, which is
exactly what a stagflation profile can expose when customer behavior shifts
quickly.
The first pressure point is net
interest income. In stagflation, rates can remain higher for longer, but
deposit behavior becomes less predictable. Deposit betas may rise as customers
demand higher yields, while non-maturity deposits that were once “sticky” can
reprice faster or leave altogether.
That earnings sensitivity is often
compounded by embedded optionality: early loan prepayments can drop when rates
are high, extending asset duration just as funding costs climb, while callable
liabilities and product features behave differently than models expect.
IRRBB frameworks require banks to
measure both earnings and economic value impacts, which can diverge sharply in
volatile rate paths.
The second pressure point is
valuation and capital sensitivity. Higher and more volatile rates can drive
sharp economic value swings in banking book positions, particularly where
hedges are imperfect or where basis risk emerges between hedged items and hedging
instruments.
In a stagflation scenario, spread
volatility can also rise, increasing the risk that credit spread moves bleed
into banking book valuations and hedging effectiveness.
That is why robust stress design
matters: banks need scenarios that combine persistent inflation, uneven growth,
and unstable term premia rather than relying on neat parallel curve shifts.
Liquidity risk rises alongside IRRBB
because stagflation changes incentives for depositors and counterparties.
When real incomes are pressured and
markets are choppy, customers become more rate-sensitive and more willing to
move balances.
At the same time, wholesale funding
can become more expensive or less reliable, especially for institutions reliant
on short-term refinancing in foreign currency.
Regulators have explicitly warned
that dependence on short-term dollar refinancing can become a bottleneck in
stress, turning market moves into funding strain.
