The end of historically low interest rates has been described as good news for banks, which are making more money as the difference between their fees on borrowers and what they pay for financing widens, but recent crises in the banking sector show that the reality is more complex.
Some banks, especially in Europe, are stuck on large loan books at fixed interest rates well below current levels, as others with a higher share of their book at variable rates can immediately charge more outstanding loans but risk a wave of default by borrowers who can no longer afford to service their debt.
He added that there is also the issue of government bonds, where banks hold more liquidity after post-financial crisis regulations limited risk, as the value of bonds bought a year ago fell because they offer lower interest rates than those sold today, which is good unless banks have to sell them to meet depositors' demands.
Bond portfolio losses
Banks are buying highly safe government debt as a way to meet regulatory requirements to hold a sufficient amount of high-quality liquid assets, but rising interest rates have led to a sharp drop in the value of these bonds, with the Federal Reserve saying that US banks have $620.4 billion in losses in their securities portfolios at the end of 2022. Under US rules, lenders do not have to account for market-related losses in their profits or capital ratios, so most have not hedged against this possibility.
When a bank finds itself short of cash to meet deposit outflows – as happened to Silicon Valley Bank (SVB) – it may be forced to sell part of its portfolio "held to maturity", which can worry investors and depositors.
Fixed Interest Rate Loans
Those who are able to pass on rate increases to customers – via variable interest rate loans – have enjoyed a significant rise in profits in 2022, as fixed-rate loans have a lower chance of default but also represent a burden on profitability for banks whose financing costs will increase.
Variable-rate loans are becoming more common in the eurozone, but fixed mortgages still account for about 3 quarters of the total, according to data from the European Central Bank, while the picture looks more complicated in the United States, where adjustable-rate mortgages account for less than 10% of total mortgages, but 36% of those on banks' balance sheets, according to data from the Federal Deposit Insurance Corporation.
One area of focus is banks' relationship with the burgeoning world of private credit, with leveraged loans at the top of regulators' watch lists, which private equity groups typically use to fund their own acquisitions.
Leveraged loans typically combine high leverage, strong repayment assumptions, weak commitments, or terms that allow borrowers to increase debt, including drawing on additional facilities.
Credit to hedge funds, which have made big bets on interest rates, is another area that banks are watching carefully.
When interest rates and inflation rise, savers expect their deposits to do better, but this doesn't always happen at banks, which can lead customers to take their money elsewhere. In the US, total bank deposits have fallen 3.3% since the Fed began raising interest rates last year, and this decline accelerated shortly after the collapse of Silicon Valley and Signature banks, as deposits in US banks fell in the seven days to March 15, equivalent to a year-long decline.
In the euro zone, depositors have withdrawn 214 billion euros over the past five months, or 1.5 percent of total deposits, according to data published by the European Central Bank this week, and the decline accelerated in February, the last month for which data are available, as depositors reduced their holdings by 71.4 billion euros, the biggest monthly decline since records began in 1997.