Navigating the Profitability Squeeze: How Weak Output and High Rates Reshape Global Financial Markets

Global financial markets are entering a period of acute stress as weak economic output collides with persistently high interest rates. Traditionally, these two forces acted as counterweights—tepid growth would prompt central banks to ease, while tight monetary policy usually accompanied strong demand. Today, the world faces an unusual dual squeeze: subdued GDP expansion alongside interest rates at multi-decade highs. For banks, insurers, and asset managers, this is not a temporary headwind but a structural transformation that is rewriting the rules of financial intermediation.

Drawing on analysis from the Economist Intelligence Unit (EIU), this article examines how the profitability squeeze is forcing hidden shifts in business models, risk appetite, and capital allocation. From the threat of a credit crunch to the quiet migration of insurance funds into private infrastructure, these changes will reverberate long after the current cycle ends.

---

The Macroeconomic Squeeze: Stagnation Meets Monetary Tightening

The first layer of the squeeze is straightforward yet unprecedented in the post-global-financial-crisis era. Global GDP growth has slowed to around 2.5% in 2024–2025, according to EIU projections, weighed down by weak consumer demand, anaemic investment in developed economies, and a sluggish recovery in China. At the same time, central banks—led by the Federal Reserve and the European Central Bank—have held policy rates at levels not seen since the early 2000s, determined to anchor inflation expectations.

What makes this combination so damaging is the feedback loop. In previous cycles, low growth would have prompted rate cuts, easing the burden on borrowers and supporting asset prices. Conversely, high rates would have been accompanied by booming demand, allowing financial intermediaries to pass on costs. Today, neither relief mechanism operates. The result is a profitability squeeze that compresses margins across the financial sector.

[IMAGE: A chart comparing global GDP growth vs. central bank policy rates over the last decade, highlighting the current divergence between weak output and elevated rates. The chart should show a widening gap in 2023–2025.]

EIU insight: The EIU forecasts that real GDP growth in advanced economies will remain below 1.5% in 2025, while policy rates will stay at restrictive levels until at least mid-2026. This prolonged “higher-for-longer” scenario creates a fundamentally different operating environment for financial firms than the low-rate, high-growth paradigm that dominated the 2010s.

---

Banks Under Pressure: Net Interest Income vs. Rising Default Risks

At first glance, higher interest rates should be a boon for banks. Net interest margins (NIMs) typically expand as lenders reprice floating-rate loans faster than deposits. Indeed, many large U.S. and European banks reported higher NIMs in 2023–2024. But this short-term benefit is being eroded by two powerful forces: weakening loan demand and rising credit risk.

When economic output is stagnant, businesses postpone capital spending and households curb borrowing. Loan books shrink in real terms, limiting the volume base on which margins are earned. More critically, higher rates increase the debt-service burden on existing borrowers. Non-performing loan (NPL) ratios have started to creep up in sectors such as commercial real estate, consumer credit, and small-business lending. The EIU’s latest financial risk assessment notes that the NPL ratio for euro-area banks could rise to 4.5% by end-2025, up from 2.1% in 2023.

Deep insight: The real danger lies in a self-reinforcing credit crunch. As banks become more cautious, they tighten lending standards—reducing credit availability precisely when the economy needs it most. This further depresses output, which in turn generates more defaults. Central banks, constrained by inflation, cannot cut rates to break the cycle. The EIU identifies this feedback loop as the single largest downside risk to financial stability.

[IMAGE: Infographic showing a simplified bank balance sheet with arrows indicating shrinking loan volume (downward) and increasing provisions for bad debt (upward). A feedback loop arrow connects “tighter lending” to “lower output” to “more NPLs”.]

Structural shift: To survive this squeeze, banks are being forced to accelerate digital transformation. By automating lending processes, reducing branch networks, and adopting cloud-based core systems, lenders can lower their cost-to-income ratios. The EIU projects that cost-income ratios among top-tier global banks will need to fall below 55% to sustain return on equity targets under current conditions. This shift is permanently altering bank business models, moving them away from relationship-based lending toward algorithm-driven, fee-oriented intermediation.

---

Insurers: Solvency Margins and the Hunt for Yield

For insurers, the profitability squeeze is less obvious but equally corrosive. While nominal bond yields have risen, real yields—adjusted for inflation—remain low or even negative in many markets. This is a critical problem for life insurers, whose liabilities stretch decades into the future. They rely on long-duration, safe assets such as government bonds to match obligations. When real returns are inadequate, solvency margins shrink.

The EIU’s insurance sector report highlights that the average solvency ratio for European life insurers declined from 220% in 2021 to roughly 185% in 2024, driven by mark-to-market losses on bond portfolios and rising liability valuations. Non-life insurers face a different but equally severe pressure: soaring reinsurance costs. The 2024–2025 hard market in catastrophe reinsurance has pushed up premiums for property and casualty lines, squeezing underwriting margins.

Deep insight: Insurers are responding by making a structural shift toward alternative assets. To achieve the yield needed to meet policyholder guarantees, they are increasingly allocating capital to private credit, infrastructure debt, and real estate. This migration—already visible in Canada’s pension giants and Europe’s largest life insurers—represents a fundamental change in risk appetite. The EIU estimates that alternative assets could account for 25% of global insurer portfolios by 2030, up from 12% in 2020. This exposes insurers to liquidity and valuation risks that were previously negligible.

[IMAGE: A split diagram. Left side: a sinking ship illustration labeled “Solvency Ratio Decline” with a downward arrow. Right side: investment flow arrows moving from a safe bond icon to wind turbines, data centers, and private credit logos – representing the shift to alternatives.]

Regulatory implications: Regulators are closely watching this trend. The EIU notes that both the European Insurance and Occupational Pensions Authority (EIOPA) and the National Association of Insurance Commissioners (NAIC) are updating stress-test scenarios to account for illiquid asset exposures. Insurers that fail to manage duration mismatches could face capital surcharges, further compressing profitability.

---

Fund Managers: Valuation Disconnects and Redemption Risks

The asset management industry is caught in a valuation paradox. Weak economic output undermines corporate earnings growth, while high interest rates discount future cash flows more heavily. The result is that equity valuations—despite recent corrections—remain stretched relative to historical norms, especially in growth sectors like technology. Similarly, corporate bond spreads have widened but not enough to reflect genuine default risk in a slowing economy.

Fund managers face a double bind. On one hand, mark-to-market losses on existing portfolios erode net asset values and trigger redemption requests. On the other hand, the fear of being caught in a liquidity mismatch—particularly in open-ended funds that hold illiquid assets like real estate, private equity, and infrastructure—forces managers to hoard cash, sell liquid securities, or gate redemptions. The EIU’s asset management risk index rose to its highest level since 2008 in Q1 2025, driven by these dynamics.

Deep insight: The greatest vulnerability lies in open-ended real estate funds. With commercial property values falling 15–20% from peak and transactions at a standstill, many funds are pricing assets based on stale valuations. When investors attempt to redeem, the gap between stated NAV and actual liquidation value becomes a systemic risk. The EIU warns that a disorderly wave of redemptions in 2025–2026 could force fire sales, amplifying price declines and spilling into other asset classes.

[IMAGE: A conceptual split-screen: left side shows a stock chart with a disconnect between a high valuation line and a downward-trending earnings line; right side shows a “Redemption” sign with a crowd of small figures trying to exit a building labeled “Open-Ended Real Estate Fund”.]

Asset allocation response: In response, institutional fund managers are rebalancing toward short-duration bonds, cash, and inflation-linked securities. They are also increasing allocations to private credit, where floating-rate instruments offer a natural hedge against rising rates. The EIU predicts that global fund flows into private credit will exceed $200 billion annually by 2026, further blurring the line between traditional asset management and banking.

---

Conclusion: A Lasting Reshaping of Financial Intermediation

The profitability squeeze driven by weak output and high interest rates is not a cyclical blip. It is accelerating structural changes that will define global financial markets for the next decade. Banks are pivoting from net interest income to fee-based digital services. Insurers are trading safety for yield in alternative assets. Fund managers are confronting liquidity risks that challenge the very design of open-ended investment vehicles.

For investors and policy professionals, the key takeaway is that financial intermediation is becoming more fragmented and more opaque. The old assumption that banks, insurers, and asset managers operate in distinct risk tiers no longer holds. They are all, in different ways, exposed to the same macroeconomic squeeze—and their responses are creating new interlinkages that regulators are only beginning to map.

The EIU’s baseline scenario suggests that the global financial system will avoid a full-blown crisis, but only if central banks begin to ease by late 2025. If high rates persist into 2026, the risk of a credit crunch—triggering widespread defaults and market dislocations—becomes material. In either case, the financial landscape that emerges will look very different from the one that entered this cycle.

Keywords: global financial markets, interest rates, economic output, bank profitability, insurance sector, asset management, EIU, credit crunch, financial stability.

---

This article is based on analysis published by the Economist Intelligence Unit (EIU) in its Q2 2025 Financial Services Outlook. All projections and risk assessments reflect EIU’s independent research.