Interest

Rate Pass Through

Case Study KBC group

ADVANCED FINANCE, BANKING & INSURANCE

GROUP 15

Samuel Michaels (2636827), Thomas Schoemacher (2652530),

Luc de Vries (2539283) & Lennart Zandbergen (2644049)

29-10-2018

Managerial summary
How does a 200 basis point increase in market interest rate impact the profitability of
banking? This paper performs a quantitative research on the effects of a 200 basis point
increase in market interest rate on the profitability of the Belgian financial
conglomerate KBC. This question is explored through a thorough analysis of the interest
rate incomes and expenses. In a regression analysis, we estimate the pass through of the
increase in market rate on the interest income and the interest expenses of KBC. From
the models, which appear to be valid following the six OLS assumptions as stated by
Stock and Watson (2014), it is derived that an increase of 100 basis points in the yield of
triple A rated government bonds with a maturity of five years, a proxy for long term
market interest rates, implies an increase of about 32.54 basis points in KBC’s interest
earnings. At the same time, an increase of 100 basis points in EONIA, the overnight rate
used for liabilities, which has lower maturities, leads to an increase of 15.98 basis points
in interest expense. On a net basis, the margin between the interest earnings and
expenses is 16.56 per 100 basis points, meaning an increase in profitability for KBC if
the market rate increases.
In order to best profit from this increase in the market interest rates, we
recommend KBC to focus on three things: First, expanding its activities in the relatively
more profitable Eastern European markets while improving cost-efficiency in its
Belgian business unit, which is bigger but also has significantly higher costs. Second, we
recommend further integration of KBC’s banking and insurance business. Through long-
term liabilities from the insurance division, maturity mismatches can be offset. Further
advantages are financial diversification of business risks, increased economies of scale
and more cross-selling of insurance products to banking customers. Third, we advise an
active stance in setting interest rates in response or anticipation of increases in market
interest rates. We advise to increase the interest rates on KBC’s assets by 35 basis
points for every 100 basis points in market rate (EURIBOR), based on the analysis of
previous rate setting, and to increase the interest rate on KBC’s liabilities by 14 basis
points for every 100 basis points in market rate (EIONIA).

Group 15 Interest Rate Pass Through: case study KBC Group 1

1. Introduction
This paper examines the effects of interest rate hikes in relation to KBC, a large Belgian
financial conglomerate. This topic is relevant because of the interest rate policy of the
European Central Bank (ECB). In the wake of the financial and sovereign debt crisis that
hit the European Union, and mainly the PIIGS (Portugal, Ireland, Italy, Greece and Spain)
from 2010 onwards, the ECB lowered its main policy rate to historically low levels. The
central bank aimed to reduce stress on the banking sector and help foster economic
growth by increasing lending, investments, and consumer spending. At the same time,
the ECB started a policy of quantitative easing (QE), in which the central bank system
buys corporate and sovereign bonds. Both policies, which mirrored measures taken by
the United States Federal Reserve, the Bank of England and the Bank of Japan, had the
effect of lowering yields and flattening the yield curve. On top of that, ECB governors
practiced a policy of forward guidance, in which market participants received
indications on the future of current policies.
Because of the solid growth levels throughout the Eurozone and rising inflation
levels, the ECB now aims to increase its interest rates. This move is also motivated by
fears that the central bank would not be able to soften the effect of a potential future
economic downturn if interest rates are minimal already. This paper will examine the
effect of an increase in market interest rates by 200 basis points over two years.
Analysing the effects of this increase in market rates specifically on KBC is fitting,
because this financial institution combines insurance and banking, two activities that
pair very different maturity levels in their assets and liabilities. However, the main focus
of this research will be on the banking activities.
Interest rates thus have a large effect on bank profitability. In the lending and
borrowing process in banking, profits are determined by the spread between the
lending rate and the borrowing rate. Because the loans are usually long-term
(mortgages, for example) and deposits are short term, banks perform maturity
transformations , as explained by Entrop et al (2014). Changes in the yield curve, as for
example caused by an increase of market interest rates of 200 basis points, could reduce
the net present value of existing loans. Apart from this valuation risk, there is a risk that
reinvestment of short-term maturities becomes disadvantageous for the financial
institution. For a visualization of both the short term and long term market interest
rates, a graph is displayed in appendix 1.

Group 15 Interest Rate Pass Through: case study KBC Group 2

 During the financial crisis, KBC received around €7 billion in state aid from the
federal Belgian government and the Flemish government. The European Commission
then ordered the bank to restructure and sell off some high-risk subsidiaries. By 2015,
the bank had paid back all aid it had received including interest, a total of €13.09 billion.
Today, KBC Group, has total assets of €292 billion, consists of three business
units: a Belgian one, a Czech one and an international markets unit, which is active in
Hungary, Slovakia, Bulgaria and Ireland. As can be seen in table 1, the domestic branch
is still the most significant for KBC. According to the classification of European banks
made by Schoenmaker (2014), its focus on a limited number of countries with
significant assets outside its home base makes KBC a semi-international bank.

Deposits Loans Net income

Belgium 132 881 (68.6%) 94 495 (67.0%) 1 432 (59.0%)

Czech 30 246 (15.6%) 22 303 (15.8%) 592 (24.6%)

International markets 22 663 (11.7%) 24 201 (17.2%) 428 (17.6%)

Table 1. Characteristics of different business units (in € million, end of 2017)

2. Theoretical Framework
2.1 Net Interest Income
In its simple form, the net interest income (NII) can be described as: the interest
payments on assets minus the interest payments on liabilities. To analyse the NII in
more detail it is split into income from commercial margins, income from maturity
transformation and income from equity (Chaudron, 2016).
It is assumed that the interest earned on assets and paid on liabilities consists of
a risk free rate and a margin. The NII can be written as:

NIIi = (ria + mia) * BAi – (riL + miL) * BLi (2.1.1)

In this formula, BAi stands for the book value of assets, BLi for the book value of
liabilities. ria represents the risk free interest rate earned by the assets, mia stands for

Group 15 Interest Rate Pass Through: case study KBC Group 3

the interest margin earned on assets, riL portrays the risk free interest rate paid on
liabilities and miL stands for the interest margin paid on liabilities. BAi is calculated as
BAi = BLi + Ei and Ei stands for the book value of equity (Chaudron, 2016).
This brings us to the following equation for net interest income:

NIIi = [(ria - riL) * BAi] + [(mia - miL) * BAi + miL * Ei] + [riL * Ei] (2.1.2)

In this formula, the first square bracket stands for the income from maturity
transformation, the second square bracket stands for net commercial margins, the third
square bracket stands for interest income from equity-financed assets, and Ei is derived
as Ei = BAi - BLi.

2.2 Duration Gap
Essentially the duration gap analysis is concerned with the interest rate risk of banks. It
is determined by the difference in maturity of the bank’s assets and liabilities. If the
duration of the assets is higher than the duration of the liabilities, then an increase in
interest rates will lead to assets decreasing more than the liabilities and thus the equity
decreasing as well. This also goes the other way around.
A strategy for banks to minimise their interest rate risk is to shorten the
duration of its assets by purchasing assets with a shorter maturity or turning fixed-rate
loans into variable-rate loans. Another strategy for banks is to increase the duration of
its liabilities. This way the bank reduces its exposure to interest rate risk.
The duration gap is calculated as follows:

DURGAP = DURA – ( * DURL) (2.2.1)

in which DURGAP stands for Duration Gap, DURA stands for the duration of assets, DURL
is the duration of liabilities and A & L stand for assets and liabilities respectively.
The downside to this method is that it can be very costly for a bank to alter its
balance sheet and it is therefore it is unusual for a bank to take such drastic measures.
Financial instruments such as futures, options, etc. help banks manage their interest
rate risk without altering and restructuring its balance sheet.

Group 15 Interest Rate Pass Through: case study KBC Group 4

 Data regarding the maturities of KBC’s assets was taken from KBC’s yearly risk
reports. These are divided into maturity buckets of: < 1 year, 1 – 5 years, 5 – 10 years, >
10 years and Until further notice (Exposure without a concrete end-date is assigned to
the 'Until further notice' category). These are further divided into the following
categories: sovereign, institutions, corporates, SME corporates, retail and residential
mortgages. The data for the maturities of KBC’s liabilities was gathered from ALM
section in the annual report of 2017.

Graph 1. Asset duration KBC group

2.3 Net Interest Margin
The Net Interest Margin (NIM) is composed of the interest earnings and interest
expenses. By subtracting the expenses from the earnings the NIM is calculated relative
to the interest earning assets. In other words, the NIM reflects the profitability of KBC.
However, for the setting of rates it is more insightful to look at the margin separately
from interest earning assets and that is what in this paper is referred to as the margin.

3. Methodology
3.1 Variables
The variables utilised in our statistical analysis are mainly adapted from Entrop et al.
(2015), who performed a convincing review of previously-used methods. Quarterly data
is used from the first quarter of 2006 up until the fourth quarter of 2017. For the first
two quarters of 2018, the data was not yet complete and hence not incorporated. For

Group 15 Interest Rate Pass Through: case study KBC Group 5

each variable used in our model, a description of the variable, the used marker and the
expected impact on the interest earnings and expenses of KBC are given below.
Furthermore, the descriptive statistics are displayed below in table 2. The actual
regression equations can be found below as well. Since one of the objectives of this
research is to determine the pass through of a change in market interest rates to the
interest earnings and expenses of KBC, two different regression models are created.
The first one (equation 3.1.1) is used to examine the pass through on the asset side of
KBC, the second one (equation 3.1.2) to examine the pass through on the liability side.
From here, the first equation is further referred to as model 1, and the second as model
2. For this research, the most prominent results will be the estimated values of 𝛽" and
𝜃" , since those are needed to make an estimation of the speed with which an increase in
market interest rates is passed through to the rates set by KBC.

Table 2. Descriptive statistics

𝐼𝑁𝑇𝐸𝐴𝑅𝑁 = 𝛼 + 𝛽" (𝐿𝑀𝐸𝑈𝑅𝐼𝐵𝑂𝑅) + 𝛽5 (𝑉𝐿𝑀𝐸𝑈𝑅𝐼𝐵𝑂𝑅) + 𝛽7 (𝑅𝑖𝑠𝑘𝐴𝑣𝑒𝑟𝑠𝑖𝑜𝑛) +

𝛽@ (𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛𝐵𝑒𝑙𝑔𝑖𝑢𝑚) + 𝜀 (3.1.1)

𝐼𝑁𝑇𝐸𝑋𝑃 = 𝛿 + 𝜃" (𝐸𝑂𝑁𝐼𝐴) + 𝜃5 (𝑉𝐸𝑂𝑁𝐼𝐴) + 𝜃7 (𝑅𝑒𝑠𝑒𝑟𝑣𝑒𝑠) +
𝜃@ (𝐺𝐷𝑃𝑔𝑟𝑜𝑤𝑡ℎ𝐵𝑒𝑙𝑔𝑖𝑢𝑚) + 𝜔 (3.1.2)

EONIA, the Euro OverNight Index Average, is the reference rate for many loans
noted in euro. This rate is expected to be an important determinant of interest expense,
because of the short maturity characteristics of the liabilities. Low market rates make it
difficult for banks to make a profit on their loans, as they hit the zero lower bound
(ZLB). As Chaudron (2016) states, extremely low interest rate levels, such as those in
the past few years, can erode the profitability of a bank. Therefore, it is expected that a
higher EONIA leads to a higher interest expense.

Group 15 Interest Rate Pass Through: case study KBC Group 6

 Volatility of EONIA (VEONIA), is measured using the standard deviation of the
EONIA for every quarter. This variable is added because volatility in market rates could
influence the expense setting decision made by KBC. It is expected that the volatility has
a positive impact on interest expense, because a more volatile market implies more risk
and thus higher required returns for debt holders.
Long-maturity-interest-proxy (LMEURIBOR), is created in order to mimic the long
maturity characteristics of KBC’s assets. As seen in chapter 2.2, the average maturity is
about five years. Therefore, AAA-rated government bond yield with a maturity of five
years is used as a proxy of long term market interest rates. It is expected that a higher
market interest leads to higher interest earnings, because the effect of the ZLB is
mitigated.
Volatility of long maturity interest proxy (VLMEURIBOR), is measured using the
standard deviation of the long-maturity-interest-proxy for every quarter. As in
accordance with the volatility of the EONIA, this variable is added as well because
volatility in market rates could influence the expense setting decision made by KBC.
Expected is that the volatility has a positive impact on interest earnings, because a more
volatile market implies more risk and thus higher required returns.
Risk aversion (RiskAversion) is proxied by the equity over total assets, as done by
Maudos and De Guevara (2004). The marker used, is the amount of capital held by KBC
above the capital required by the regulator. A high level of risk aversion can indicate
that market conditions are bad and obtaining profitable yields is difficult. Therefore, we
expect higher values for risk aversion to be associated with lower interest earnings.
Cash reserves (Reserves) are proxied by cash and cash balances at central banks
over total assets, as is also done by Entrop et al. (2015). We expect a positive
relationship associated between with the level of reserves and interest expense, and a
negative relationship between reserves and interest earnings, because more cash
reserves can be associated with less investment opportunities.
Gross Domestic Product (GDPGrowthBelgium) is included through quarterly
figures for Belgian GDP growth rate relative to a year earlier. This macroeconomic
variable is used following Entrop et al. (2015) to control for demand and supply of
loans. A rapidly expanding economy has higher levels of investment, which requires
more loans. It is therefore expected that the GDP level will lead to higher interest
earnings because of the increase in demand. Only the levels for Belgium are used

Group 15 Interest Rate Pass Through: case study KBC Group 7

because the largest part of KBC’s business is concentrated in Belgium, hence a european
level would not be fitting.
Inflation (InflationBelgium) controls for effects on rising interest rates and rising
interest incomes that are mitigated through rising inflation levels if the loans are
nominal and not corrected for price index changes. Hence, higher inflation levels are
estimated to yield higher interest earnings and interest expenses. Just as for the GDP
level, only the levels for Belgium are used because the largest part of KBC’s business is
concentrated in Belgium.

3.2 Validity of the models
When designing the models, a lot of emphasis is placed on their validity. In order to be
able to draw accurate conclusions, the models must be valid from an econometric point
of view. As for this econometric part, six fundamental OLS assumptions, as defined by
Stock and Watson (2014), are tested. First, the assumption of linearity states that the
model is linear and is indeed used to explain a linear relationship between the
dependent variable and the independent variables. Second, the residuals follow a
normal distribution. Third, the residuals have a conditional mean of zero. Fourth, no
multicollinearity exists. The fifth assumption states that the residuals need to be
homoscedastic. Finally, the sixth assumption states that the correlation between the
residuals and the independent variables must equal zero.
In order to test for each of these assumptions in Stata, a guide, written by the
Institute for Digital Research and Education (n.d.), is followed. The first assumption is
tested by creating a scatter plot of the residuals against the independent variables, one
at a time. These scatterplots are examined for any distortions in the distribution of the
residuals. The second assumption is tested with the Shapiro-Wilk W test, which yields a
p-value that tests the null hypothesis of the residuals following a normal distribution; a
large p-value means that the residuals are indeed normally distributed. The third
assumption is tested by predicting the residuals and then summarizing them in Stata to
examine their means, which should be zero. The fourth assumption is tested using the
Variance Inflation Factor (VIF) command right after the regression is performed. As a
rule of thumb, variables with a VIF value greater than 10 need further investigation in
terms of multicollinearity. The fifth assumption is checked by plotting the residuals
against the fitted values and performing the White’s test. Finally, the last assumption is

Group 15 Interest Rate Pass Through: case study KBC Group 8

tested by creating a correlation matrix of the residuals with the independent variables.
The results of these tests can be found in chapter 4.3.

4. Results
4.1 Model 1: interest earnings
Table 3 reports the empirical results of model 1, in which the impact of a long maturity
market interest rate and a series of control variables on the interest earnings is
estimated. The model seems reasonably well fitting, with an adjusted r-squared of
0.8836. The long maturity market interest rate proxy has a very strong positive effect
on the interest earnings (r = 0.325424 at p = 0.000). Also statistically significant is the
level of risk aversion (r = 0.101297 at p = 0.058) and reserves (r = -0.0378003 at p =
0.000). Surprisingly, the volatility in the long maturity interest rate proxy appears to
lack a significant relation to the interest earnings. This is probably caused by the fact
that the interest earnings are depending on assets with long maturities (on average
about 5 years), and are therefore not sensitive to volatility, since the rates are set for a
longer period.

Table 3. Regression output model 1

Of particular interest here is the coefficient of LMEURIBOR (0.3254), which

indicates the estimated effect of a change in the long-maturity-interest proxy on the
interest earnings of KBC. Since the main objective of this research is to estimate the pass
through of a change in market interest rates, estimating this effect is fundamental. The

Group 15 Interest Rate Pass Through: case study KBC Group 9

coefficient implies that an increase of 100 basis points in the market interest proxy
leads to an increase of about 32.54 basis points in KBC’s interest earnings.

4.2 Model 2: interest expense
Table 4 reports the empirical results of model 2, in which the impact of EONIA and a
series of control variables on interest expense is estimated. The model seems
reasonably fitting, with an adjusted r-squared of 0.8915 and only significant variables.
The EONIA has a negative coefficient association with the interest expense (r = -
0.1597767 at p = 0.000). Also statistically significant are the other independent
variables: the volatility of EONIA (r = 0.6012962 at p = 0.001), the level of cash reserves
(r = 0.0131438 at p = 0.020) and GDP growth (r = 0.0742381 at p = 0.001). However, as
can be seen, the coefficients of reserves and GDP growth are small, indicating that their
effect on interest expense might be reprehensible despite the statistical significance.
Furthermore, because this research sets out to investigate the pass through of
market interest rates, the estimated coefficient of EONIA (-0.1598) is the most
important. This coefficient implies that an increase of 100 basis points in EONIA leads to
an increase of 15.98 basis points in interest expense. The fact that the negative
coefficient still leads to an increase in expense is due to the composition of the interest
expense variable containing only negative values.

Table 4. Regression output model 2

Group 15 Interest Rate Pass Through: case study KBC Group 10

4.3 Validity
As for the econometric part of the model, the OLS assumptions specified in chapter 3.2
are tested. In total, eight scatterplots (four per model) with the residuals are created,
one for each independent variable. Only the scatterplot of Reserves seems to reveal a
small pattern in the residual distribution. However, the pattern is too weak to initiate
further investigation. Additionally, none of these scatterplots give a reason to think
about a non-normal distribution of the residuals.
The second assumption is also validated for both models, the Shapiro-Wilk W test
fails to reject the assumption that the residuals follow a normal distribution (model 1: p
= 0.11491) (model 2: p = 0.32123).
Moreover, the third assumption is validated for both models as well: the
conditional mean of the residuals is also (approximately) equal to zero (model 1: mean
= -4.46e-10) (model 2: mean = 3.64e-10).
Next, the fourth assumption is also validated for both models; none of the VIF
values are larger than 10, indicating no sign of multicollinearity.
However, the fifth assumption is not validated since the White’s test yields a p-
value of 0.0829 for model 1, and a p-value of 0.0381 for model 2. These values indicate
that in both cases the data is not homoscedastic. Due to time related limitations, the
option of testing the models with robust standard errors is used in order to correct for
the heteroscedasticity (Hoechle, 2007).
The final assumption is validated: the correlation matrix showed no correlations
between the residuals and the independent variables (appendix 2 & 3). In short, both
models are perceived to be valid in almost every OLS assumption. The problem of
heteroscedasticity is overcome by testing with robust standard errors.

4.4 Duration gap analysis
About 44% of the lending portfolio will mature within five years. Within the
‘Institutions’ and ‘Corporates’ exposure classes, this percentage even reached 67%. The
longest maturity bucket is mainly concentrated in the ‘Residential Mortgages’ class. The
rise in credit exposure with a residual maturity of 10 years and longer, was caused
primarily by new production in the ‘Residential mortgages’ category. The higher level of
cash balances at central banks was the main driver for increasing the ‘Sovereign’ (<1
year) exposure.

Group 15 Interest Rate Pass Through: case study KBC Group 11

 The duration gap analysis revealed that the interest rate risk position of KBC is
very small. It has a duration gap of 0.34 years, meaning KBC has matched the duration
of its assets and liabilities very well. Their assets reprice over a longer term than
liabilities, thus KBC’s net interest income benefits from a normal yield curve. KBC’s
economic value is sensitive mainly to movements at the long-term end of the yield curve

4.5 Pass through predictions
Following the analysis performed, a prediction can be made about the pass through rate
and speed following a possible increase in the market rate. KBC’s interest earnings
should go up by 32.54 basis points, while its interest expense should increase by 15.98
basis points, following an increase of 100 basis points in the market rate, ceteris paribus.
Hence, these findings imply that an increase in the market rate is passed through to the
profitability of KBC with some kind of lag. The profitability, reflected by the margin
between interest earnings and interest expenses as explained in chapter 2.3, is
increasing with 16.56 basis points for every 100 basis points increase in market rates,
ceteris paribus. In graph 2, a visual display of the predictions can be observed.

Graph 2. Pass through predictions. The dotted rectangle represents the prediction area starting from 01/01/2018.

When looking at graph 2, it seems odd that for the years 2018 and 2019 the
market interest rate and the interest earnings rate approach each other and intersect at
the end. For banks generally make money by adding a premium to the market interest
rate when setting their rates. Because the maturity of the KBC assets in general is longer
than the maturity of the liabilities, i.e. the deposits, one should expect the interest
earnings rate to increase in a steeper way than the market interest rate does. This

Group 15 Interest Rate Pass Through: case study KBC Group 12

deviation can be explained by the fact that the increase in interest earnings rate is not
corrected for the difference in duration. The coefficient calculated includes the assets
that are set at previous rates. This is also true for the interest expense rate, but due to
the shorter maturities this has less effect on the calculated coefficients.
When used as input in the model specified in chapter 2.1, an increase of 100
basis points in market interest rates over the period of one year would result in the net
interest income increasing by 150 to 200 basis points.

5. Strategic advice
KBC wants to be among Europe’s best performing financial institutions by
strengthening its bank-insurance business model for retail, SME and mid-cap clients in
its core markets, in a highly cost-efficient way by creating superior client satisfaction,
while focusing on sustainable and profitable growth and thus having a solid risk, capital
and liquidity management. This strategy should make KBC the reference in bank-
insurance in all of its core markets. In doing so KBC focuses on the long-term outlook of
its business units, so the sustainability of its activities in the banking and insurance
sector is stressed. Next to this, KBC emphasizes it takes its responsibilities towards
society and the local economies very seriously and aims to be one of the better
capitalised financial institutions in Europe. (KBC Financial Report 2017) This is all
considered in giving the strategic advice, which focuses on three pillars: expanding
activities in Eastern Europe; further integration of the banking and insurance business;
and the active setting of interest rates relating to a 200 basis points increase in the
market interest rates.

5.1 Expansion in Eastern Europe
As noted in the previous chapters, KBC has a very strong presence on the Belgian
market, where it makes 59% of its net income. However, the Czech and International
business unit operate more efficiently and have significantly higher profit margins. At
the same time, the economies of the Eastern European countries where KBC has a
presence, such as Bulgaria and Romania, have a higher potential of achieving high levels
of economic growth than Belgium, which is a more developed economy. Taking both
factors into account, we recommend KBC to continue its expansion in Eastern Europe

Group 15 Interest Rate Pass Through: case study KBC Group 13

while attempting to drive down overhead costs and costs related to unprofitable
activities in Belgium. Especially increasing wage costs in Belgium drive down
profitability for the group as a whole and could be saved on in the long run by using
Fintech opportunities in the banking and insurance business, like algorithmic selection
and monitoring.

5.2 Further bank-insurance integration
KBC could also profit from further integration of its banking and insurance business. In
this way, the maturity mismatches created by long-term assets and short-term liabilities
in the banking part can be offset by profiting from the longer-term insurance liabilities.
Expanding the (life) insurance activities could help in closing the duration gap even
further, which drives down refinancing risk while creating a more stable backbone for
more volatile banking business activities. This allows for financial diversification,
economies of scale and thus increase the profitability of KBC. A further integration of
the banking and insurance business will also lead to more cross-selling of products from
its insurance units through its banking division. Cross-selling related to mortgages is
already very high across KBC group with 84.5% for property insurance products and
80.0% for life insurance products and could grow even more. Therefore, KBC aims for
and should work towards acting as a single operational company: with its bank and
insurance operations working under unified governance and achieving commercial and
non- commercial synergies (KBC Financial Report 2017). Although forming a financial
conglomerate also has negative effects on a company, like cross-subsidisation and a
lower company value, we believe this is in line with KBC’s strategy because it is risk
limiting and taking responsibility towards society (De Haan, Oosterloo & Schoenmaker,
2015).

5.3 Active setting of interest rates
In maintaining a solid risk, capital and liquidity management KBC should actively set its
interest rates in response or in anticipation of increases in the market interest rates. It
should do this smoothly to not offset the superior client satisfaction and do so in stages
related to the market increase. We advise to increase the interest rates on KBC’s assets
by 35 basis points for every 100 basis points in market rate (EURIBOR), based on the
analysis of previous rate setting, and to increase the interest rate on KBC’s liabilities by

Group 15 Interest Rate Pass Through: case study KBC Group 14

14 basis points for every 100 basis points in market rate (EIONIA). This difference in
setting the rates will compensate for the fact that there is a slight duration gap between
the assets and the liabilities (0.34 years) and contribute to sustainable and profitable
growth in all core markets. We would not set the rates too high to maintain
competitiveness and thus expand their business in the growing markets of Eastern
Europe. KBC will be able to do this due to the growth in profitability and the
economization due to further integration of the banking and insurance business, which
will result in less pressure on the interest margins.

Group 15 Interest Rate Pass Through: case study KBC Group 15

APPENDIX
1. EONIA and long term interest rate over time

Graph 3. EONIA and the proxy for long term interest rates over time. The dotted rectangle indicates the predictions

2. Correlation matrix model 1

3. Correlation matrix model 2

Group 15 Interest Rate Pass Through: case study KBC Group 16

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dependence. Stata Journal, 7(3), 281.
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webbooksregressionwith-statachapter-2-regression-diagnostics/
KBC Group. (2018). Quarterly report (Q12006-Q42017). Retrieved from
https://www.kbc.com/en/quarterly-reports
Maudos, J., & De Guevara, J. F. (2004). Factors explaining the interest margin in the
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Group 15 Interest Rate Pass Through: case study KBC Group 17