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Interestraterise:Redemptionatlastforbanks?FT.com
Whisper it quietly especially if you are in the company of politicians or regulators but
banks are finally starting to find life a little easier. The pace of regulatory change is easing,
the worst of the misconduct fines seems to be out of the way and US and UK interest rate
rises are likely to be coming sooner rather than later.
Received wisdom in the banking sector is that higher rates are great news. US banks, with
their heavy domestic focus, can push a Federal Reserve rate rise (http://next.ft.com/conten
t/383eaf3c-52ff-11e5-8642-453585f2cfcd) on to many of their borrowers pretty quickly.
They can also try to delay passing the benefit on to savers for as long as possible. Foreign
banks with US operations get the same benefit, but on a smaller portion of their business.
The big benefit for them is the rise in yields from US Treasury bills and other American
debt. Almost all global banks hold a lot of US debt, since it is highly liquid.
The scenarios are being explored because the Fed is set to raise its record-low interest
rates for the first time in a decade, perhaps as early as this week.
The banks could use a boost. According to the Federal Reserve Bank of St Louis, US
banks net interest margin (the gap between what they pay for funding and what they
charge to lend) peaked at more than 3.8 per cent in 2010 and is now less than 3 per cent.
That is a big chunk of lost profits. In Europe margins are lower still Germanys Deutsche
Bank, for example, had a net interest margin of just 1.4 per cent last year.
Under Basel III regulations, the banks have to disclose some detail about what higher
interest rates would do to their businesses. JPMorgan, for example, says that a 100 basispoint rise in interest rates would add $2.8bn to net interest income (which was $39bn last
year).
And there is a more general way that higher interest rates help. Rising interest rates are a
sign of a strong economy. That will improve corporate profits and encourage companies
to expand. To finance that expansion many of them will look to the banks. Lending
volumes, then, should rise.
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So higher volumes and higher margins. Whats not to like? Potentially, quite a lot. This
happy story has plenty of worrying subplots. Three in particular should be causes for
concern. The first is the impact of rate rises on the dollar. Non-US borrowers have been
enthusiastic borrowers of dollar debt. In emerging markets (http://next.ft.com/content/a43
6ea2a-5187-11e5-8642-453585f2cfcd), for example, dollar-denominated debt has risen 81
per cent to $3.3tn over the past five years, according to the Bank for International
Settlements. Higher US rates mean a strong dollar, making the payments even more
expensive in the borrowers local currencies. Combine that with a slowdown in emerging
markets, and a move by the Fed would make a bad situation worse.
When rates rise (http://next.ft.co
m/ig/sites/when-rates-rise)
Still, if all else is equal then rising rates should be good news for banks. But all else is not
equal.
1. Steep or flat?
All banks will hope to benefit from better interest margins when rates rise. But some hope
to benefit more than others.
One of the most important drivers of bank earnings is higher interest rates, particularly
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for the US and Asian banks. Higher rates drive higher net interest income and thus affect
bank stock valuations, wrote Morgan Stanley analysts this month.
Much depends on the yield curve, or the
difference between short-term and long-term
rates. Banks, which tend to borrow in shortterm markets and lend in long-term ones, do
well when long-term rates are much higher
than short-term equivalents (or, in the jargon,
when there is a steep yield curve). But rising
rates are often associated with a flatter yield
curve (http://next.ft.com/content/186efcf2-304
5-11e5-91ac-a5e17d9b4cff).
The banks that will do best are those with
more deposits than outstanding loans. The
excess deposits tend to be invested in shortterm bonds at low yields. As soon as short-term rates rise, so do the yields on those bonds.
Chirantan Barua, analyst at Bernstein, points to HSBC as an example of a bank that can
benefit this way. It has $1.4tn of customer deposits and $954bn of customer loans. If it can
start to generate a better return on the difference, profits will jump immediately.
French banks, which tend to pay no interest on current accounts, should also do well when
the European Central Bank pushes its rates up (http://next.ft.com/content/619b139c-3ce411e5-8613-07d16aad2152) though such a move is not imminent. And Italian banks,
which are heavily deposit-funded, are also expected to be beneficiaries of higher rates.
The banks will seek to pass the rise on to borrowers as quickly as possible. But in markets
with lots of fixed-rate loans (northern Europe, for example), it will take longer to do this.
Banks with large credit card operations say it is harder to pass rate rises on to card
customers. And, faced with a rising cost of debt, borrowers with floating rate loans may
move their business elsewhere. Some banks have warned that customer attrition rates
could double when rates rise.
Finally, a number of banks will have to raise the prices they charge corporate borrowers.
Corporate lending is often used by banks as a loss leader for other business. Banks tend
to lend to corporates at a loss or at low margins, says Mr Theodore. That is harder to do
as rates go up as the opportunity cost is higher. Higher prices would mean better returns
on the lending itself, but could dissuade corporate customers from sending other, feehttps://next.ft.com/content/49f8b480525e11e5b029b9d50a74fd14
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