How Will Rising Interest Rates Affect Bank Profits?

Industry Updates  »  How Will Rising Interest Rates Affect Bank Profits?

 How Will Rising Interest Rates Affect Bank Profits?

The Fed has increased interest rates 3 times now since December of 2015 resulting in an increase in the Fed Funds Rate of 75 basis points.  As rates have been low for a long period of time, the spread between a bank’s cost of funds and the interest rates charged on loans has been squeezed over the last few years. 

Since commercial banks depend on interest income for the majority of their revenues and therefore profits, this has caused them to make changes in the way they manage their assets and liabilities as well as seek income from other sources such as fees. 

As shown by the graph below, bank net interest margins which have been falling at U.S commercial banks since 2010 are now trending upward, however slightly.  A key question is, how will U.S. banks, which have been underperforming based on stock prices relative to the overall market, be affected by a rising rate environment assuming it continues?

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While it seems fundamental that higher rates will make it easier for banks to increase profits, income as measured by return-on-assets (ROA) has been holding steady at 1.00% for banks nationwide since 2012. This is depicted by the chart below. 

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As the graph shows, ROA has been basically unchanged since 2012 – despite the continued decline in the net interest margin over the same time period illustrated by the previous graph. As shown, ROA’s leveled off to 1.00% after the economic downturn in which banks were sustaining credit losses stemming from the financial crisis.

Since ROA’s have historically been higher than 1.00%, this may suggest banks have reached a floor in which the low rates and corresponding smaller net interest margin have little effect on profits. Therefore, the rising rate environment may benefit commercial banks with respect to the bottom line. 

The New York Federal Reserve has released a study addressing this issue in more depth. The full text of the article can be found at:
http://libertystreeteconomics.newyorkfed.org/2017/06/low-interest-rates-and-bank-profits.html


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