Friday, 28 January 2022

Moody's - Rising interest rates and steepening yield curves to boost banks’ profitability

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10 June 2021 – While banks globally have had to contend with low interest rates and flat yield curves for years with little change in sight. But stronger economic activity and shifting inflationary expectations could push long-term interest rates higher in a number of countries, bolstering banks' net interest margins, Moody's Investors Service said in a report published today. 

“The shift in the interest rate cycle, should it take hold, will broaden banks' net interest margins and boost their profitability," says Alexios Philippides, a Vice President - Senior Analyst at Moody's and the author of the report. "Long-term interest rates are already picking up significantly in North America, the UK, Norway and Israel, but it will take time for bank margins to recover provided the shift in rates is sustained."

  • Stronger economic recovery for some is lifting long-term rate expectations. Most economies will return to growth this year but the recovery will be uneven. Rapid progress in vaccinations has allowed some countries to reopen more broadly and fiscal stimulus is accelerating the pace of recovery. Therefore, while global monetary policy will likely remain broadly accommodative in the near-term, faster recovery and higher inflation will contribute to yield curves steepening and an eventual rise in reference rates in some jurisdictions, provided the pandemic remains contained.

  • steepening of the yield curve will boost margins and profitability. The slope of the yield curve can have a significant impact on banks' net interest income, a key component of their profitability. This is because banks typically fund themselves at lower short-term interest rates and lend or invest at higher long-term rates, profiting from the difference. Overall higher interest rates will also be positive for some banks because a long period of ultralow rates have pushed their deposit costs against the lower bound of zero while sharply reducing asset yields, so compressing margins. Margins declined further in 2020 because the unprecedented monetary stimulus unleashed amid the pandemic-induced economic downturn further reduced rates and flattened yield curves globally.

  • Some banks will regain pre-pandemic profitability faster. Among advanced economies, a strong US economic outlook is contributing to a steeper dollar yield curve, which should gradually boost margins and therefore net interest income. European economies will take longer to return to full capacity, given a more moderate fiscal impulse, slower vaccine rollout, and structurally weaker economic growth. Likewise, we expect the Bank of Japan to maintain its loose policy stance. This will mean low interest rates will continue to depress margins for the regions' banks. Strong economic recovery also benefits banks' solvency more broadly. For banks in emerging market countries where pandemic control is lagging and where reliance on capital inflows is high, the negative effects from rising global interest rates could outweigh benefits from higher margins.


Re-disseminated by The Asian Banker


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