An analysis of Austrian banks during the high inflation period of the 1970s

Motivated by the current economic environment of high inflation and increasing interest rates, we take a closer look at the Austrian banking sector between 1969 and 1985. Given that period’s parallels to the current situation, we aim to draw conclusions about the impacts high inflation may have on banks’ profitability, balance sheet structure and risk profile. Our findings show that the period under review was characterized by a rapid expansion of banks’ total assets. From 1975 onward, profitability declined steadily, as pressure on interest margins was mounting (given increasing competition and funding costs, expansion via investments in low-yield assets and interest rate dynamics) and cost efficiency was on the decline (given increasing wages and expanding branch networks). Due to strong credit growth and risk-inadequate pricing, the cost of risk remained relatively low. Regarding the balance sheet structure, interbank lending became more important in the 1970s, while the share of customer deposits in overall liabilities declined. Finally, banks’ equity ratio contracted significantly, which indicated a lower risk-bearing capacity and a weakening capital position. The economic turbulence that characterized much of the 1970s and banks’ rapidly declining capital ratios also led to various regulatory initiatives meant to reduce the risk emerging from the expanding banking sector. A comparison with the current situation shows that, today, Austrian banks are less dependent on interbank funding and have a higher share of customer deposits. In addition, Austrian banks’ equity ratio is significantly higher today than it was in the 1970s.