Impact of Low Interest Rates on Bank’s Profitability

What is Impact of Low Interest rates on Banks’ profitability?

Fed reserve sets the monetary policy for improving employment and controlling inflation. Policy is implemented through setting up policy interest rates.

I point you to three charts below:

Effective Fed funds rate (EFFR). This rate, with high of more than 19 percent in 1981, is at 0.37 percent at present. In November 2008, the rate was at 0.39 percent and has remained low since then.  See reference (m).

Net Interest Margin of Banks has declined: Over the years, the NIM (Net Interest Margin) of banks, a measure of profitability, has eroded. Erosion continues. See the chart below reference (a).

Number of Banks in USA have declined: There were 14400 banks in 1984, 7175 in 2008, and now in 2016, there are only 5309 banks. Banks continue to fail/consolidate (M&A). See the chart below.  reference (b).

 

What does give rise to institutional cash pools and shadow banking, financial innovation (securitization), Bank failures, consolidation (M&A) and evolution of Too Big to Fail Banks, risk taking in lending and financial instability?  Rise in Debt, Credit and Capital Flows?

Too low interest rates for too long.

 

Here are some of the recent publications voicing their concerns:

2015 Annual Report of US Office of Financial Research (OFR) says:

OFR’s assessment of threats to the financial stability of the United States, discusses risk and resilience in the financial system.

The three chief threats are the: (1) impact of persistently low interest rates, (2) increasing debt and declining credit quality in U.S. corporations and emerging markets overseas, and (3) areas of weakness in the system that remain despite financial reforms and better risk management by financial companies. (page 5)

Long-term impact of low interest rates – Although some interest rates have recently moved higher, given the context just described, we expect the incentives for risk-taking from historically low interest rates to endure for some time.

Persistently low rates will continue to prompt investors to take higher risks to increase their returns on investment and may encourage excessive borrowing. (page 6)

At the media briefing of BIS Quarterly Review March 2016, On-the-record remarks by Mr Claudio Borio, Head of the Monetary and Economic Department, 4 March 2016.

But the main source of anxiety was the vision of a future with even lower interest rates, well beyond the horizon, that could cripple banks’ margins, profitability and resilience.

 

BIS views are shaped by the new research published in a paper. See reference (g).

 

Banks stocks are traded on wall street. The CEOS of banks are responsible to show revenue growth and earnings growth every quarter. How do they accomplish that in declining margins environment?

Risk taking, leverage, financial innovation, non-core business, industry consolidation, and aggressive accounting.

 

Fed policies to improve the real economy impact the banking/financial sector adversely.

I suggest that it was due to declining Interest rates in last thirty years that we had Global Financial Crisis.

 

Please take a look at latest data and research/analysis references below.

  1. Stijn Claessens, Nicholas Coleman, and Michael Donnelly, “‘Low-for-Long’ Interest Rates and Net Interest Margins of Banks in Advanced Foreign Economies,” Federal Reserve Board of Governors International Finance Discussion Papers Notes, April 11, 2016.
  2. Deutsche Bundesbank: Banks’ Net Interest Margin and the Level of Interest Rates; July 2015
  3. Atlanta Fed: Net Interest Margin Performance in a Low-Rate Environment 2012
  4. Richmond Fed: Do Net Interest Margins and Interest Rates Move Together? May 2016
  5. BIS: The influence of monetary policy on bank profitability October 2015
  6. FRB: Why are net interest margins of large banks so compressed ? October 2015
  7. Chicago Fed: What Is the Impact of a Low Interest Rate Environment on Bank Profitability? July 2014
  8. St.Louis Fed: Are Banks More Profitable When Interest Rates Are High or Low? May 2016
  9. Bank of England, UK: Simple banking: profitability and the yield curve June 2012

 

Key data and analysis sources:

 

a) Net Interest Margin for all U.S. Banks

https://research.stlouisfed.org/fred2/series/USNIM

 

b) Commercial Banks in the U.S.

https://research.stlouisfed.org/fred2/series/USNUM

 

c) Deutsche Bundesbank (German Central Bank): Banks’ Net Interest Margin and the Level of Interest Rates  July 2015

https://www.bundesbank.de/Redaktion/EN/Downloads/Publications/Discussion_Paper_1/2015/2015_07_14_dkp_16.pdf?__blob=publicationFile

 

d) Stijn Claessens, Nicholas Coleman, and Michael Donnelly, “‘Low-for-Long’ Interest Rates and Net Interest Margins of Banks in Advanced Foreign Economies,” Federal Reserve Board of Governors International Finance Discussion Papers Notes, April 11, 2016.

https://www.federalreserve.gov/econresdata/notes/ifdp-notes/2016/low-for-long-interest-rates-and-net-interest-margins-of-banks-in-advanced-foreign-economies-20160411.html

 

e) Atlanta Fed: Net Interest Margin Performance in a Low-Rate Environment; Viewpoint Vol 25/4, 4th quarter, 2012

https://www.frbatlanta.org/banking/publications/financial-update/12q4/12q4_vp_net_interest.aspx

 

f) Richmond Fed: Do Net Interest Margins and Interest Rates Move Together?; Economic Brief No. 16-05, May 2016

https://www.richmondfed.org/publications/research/economic_brief/2016/eb_16-05

 

g) BIS: The influence of monetary policy on bank profitability; October 2015

http://www.bis.org/publ/work514.pdf

 

h) OFR Annual Report 2015

https://financialresearch.gov/annual-reports/files/office-of-financial-research-annual-report-2015.pdf

 

i) BIS Quarterly Review March 2016 – Media Briefing

http://www.bis.org/publ/qtrpdf/r_qt1603_ontherecord.pdf

 

j) FRB: Why are net interest margins of large banks so compressed ?; Feds Notes October 2015

https://www.federalreserve.gov/econresdata/notes/feds-notes/2015/why-are-net-interest-margins-of-large-banks-so-compressed-20151005.html

 

k) Chicago FedWhat Is the Impact of a Low Interest Rate Environment on Bank Profitability?; Chicago Fed Letters, No. 324, July 2014

https://www.chicagofed.org/publications/chicago-fed-letter/2014/july-324

 

l) St.Louis Fed: Are Banks More Profitable When Interest Rates Are High or Low?; On the Economy, May 16, 2016

https://www.stlouisfed.org/on-the-economy/2016/may/banks-more-profitable-interest-rates-high-low

 

m) Effective Fed Funds Rate

https://research.stlouisfed.org/fred2/series/FEDFUNDS

 

n) Bank of England, UK: Simple banking: profitability and the yield curve; Piergiorgio Alessandri and Benjamin Nelson; June 2012

http://www.bankofengland.co.uk/research/Documents/workingpapers/2012/wp452.pdf

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Author: Mayank Chaturvedi

You can contact me using this email mchatur at the rate of AOL.COM. My professional profile is on Linkedin.com.

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