How Are Lower Interest Rates Impacting Banks’ Margins?



Squeezed margins

Lower interest rates on a sustained basis have negatively impacted the performance of the US banking sector. While interest rates that banks earn on loans have declined, borrowing cost cannot fall below zero. So banks are not able to use much deposit pricing strategies to boost margins. As a result, the relative value of lower cost deposits has decreased significantly. The result is lower margins for most US banks.

The graph above shows net-interest margins (or NIMs) for all institutions insured by the FDIC (Federal Deposit Insurance Corporation). NIMs have been on a declining trend for four years.

Lower net interest margins have negatively affected big banks such as JP Morgan (JPM), Bank of America (BAC), Citigroup (C), and Wells Fargo (WFC). They have consequently affected the Financial Select Sector SPDR ETF (XLF) and the iShares U.S. Financials ETF (IYF).

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Impact of the slope of yield curve

While short-term interest rates are set by the Federal Reserve, longer-term rates are determined by the market. A rise in longer-term yields is an indication of an improving economy. Lower economic growth expectations result in a flattened yield curve structure. Longer-term yields are also affected by long-term inflation expectations and central bank activities.

Banks typically borrow short-term and lend longer-term, which results in maturity transformation. Loans that banks give are generally longer-term. These loans are funded in large part by shorter-term deposits.

So banks benefit from a steeper yield curve. A steep curve allows banks to lend on the higher long-term rates while borrowing on the lower short-term rates. This boosts margins for banks.

Flattening yield curve

Concerns about global economic growth are contributing to the flattening of the yield curve. Falling oil prices are also lowering inflation expectations, causing longer-term yields to decline.

At the same time, an expected short-term interest rate hike by the Fed is causing yields on shorter-term securities to rise. This is further flattening the yield curve. This might impact banks’ performances negatively.


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