I fell a little down the rabbit hole of this Journal article on “Low Rates Pummel Banks.” This has long been a mystery to me as there are two diametrically opposite narratives of banks and low rates in the world. In one, banks borrow for free from the Fed and reinvest at higher rates and print free money and spend it on parties where they beat up retirees. In the other, banks are, um, pummeled by low rates. Neither of those theories is absurd on its face, as you can tell from the Journal article:
Superlow U.S. interest rates are squeezing bank profits, complicating the industry’s nascent recovery from the financial crisis. … U.S. banks earned $114.39 billion last year, their best showing since 2006.1
Profits are squeezed, but to their best level since before the financial crisis, so.
The Journal’s thesis is basically that banks are getting screwed because net interest margin, specifically, is squeezed, as mortgage rates keep dropping, deposit rates are kind of floored and can’t drop any further, and other sources of revenue are drying up:
As higher-yielding loans and securities acquired before the crisis mature, the banks are forced to replace them with assets that carry much lower rates. With some sources of lucrative fee income such as debit card charges capped in 2010′s Dodd-Frank law, the margin squeeze has an outsize impact on the bottom line.
On the other hand, other other sources of revenue, like originating mortgages at record spreads to MBS rates, or just trading securities whose prices have been bolstered by declining rates, are still robust – but that business seems to be concentrated in big banks that also benefit from economies of scale. A Goldman equity research note yesterday came to the same place, noting that regional banks get ~58% of revenue from net interest while the big universal banks get only ~48% there:2 Read more »