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How Does NIRP Affect Banks?

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NIRP would hurt banks’ profitability

If the Federal Reserve decides to adopt a negative interest rate policy (or NIRP), Wall Street banks will feel the pain.

Interest rates are the most important driver for banks, as they determine their net interest margins. Banks are in the business of funding their long-term loans by short-term liabilities in the form of deposits. The spread between what they earn on these loans and what they pay out as interest on these deposits is called net interest income.

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As the yield curve steepens, these margins grow, thus improving profitability for banks. Inversely, when policy rates turn negative, banks will have to pay interest on the excess reserves stored with the Federal Reserve. This means banks hold low reserves and have more cash available to give out as loans. However, it could also lead to lower demand for loans in a stagnant economy.

So if central banks adopt a negative interest rate policy, banks stand to lose billions of dollars of revenue on their deposits with the Federal Reserve. In 2015, banks had $911 billion of deposits with the Fed, on which they earned nearly $5.9 billion. Interest earned on bank deposits account for roughly 1.9% of banks’ revenues.

Impact on stocks

If NIRP comes into effect, we can expect to see shares of consumer banks such as Wells Fargo (WFC), JP Morgan (JPM), Bank of America (BAC), and Citigroup (C) nosedive. ETFs tracking these banks would also suffer. Banks constitute ~48% of the Financial Select Sector SPDR ETF (XLF).

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