August 25, 2015

Banks Struggle to Increase Profits: Higher Interest Rates Are Not the Solution

Higher interest rates alone won't necessarily help earnings for banks.

Banks across the US have been waiting patiently for stubbornly low interest rates to finally rise, which in theory would help boost profits. But a hike in interest rates alone isn't enough.

Following the economic post-crisis, the Fed has kept interest rates extremely low as part of its recovery effort. Yet while banks are anxiously awaiting rates to rise, this increase won't necessarily help stock prices to beef up.

Of course, a rate increase will give banks a chance to originate and/or purchase new assets at higher interest rates than the current low yields. However, consumers may choose to forego their current low cost deposits in exchange for higher-yielding options upon a rate hike.

And with the ease and low cost of moving money thanks to the advent of technology, banks may experience a certain level of liquidity risks. For this reason, it's highly possible that any advantages of higher interest rates will be short-lived, at least at the forefront.

Many banks - particularly smaller ones - have found themselves holding onto an increased number of low-interest, long-term loans as a result of the stretched out low interest environment. As such, these financial institutions are in a risky position to experience capital losses as asset values decline when interest rates start to rise.

Optimism among banks for an interest rate increase seems logical. But it's important not to overemphasize the positive effect this could have on their bottom line. Without a thorough and complete analysis of these upcoming changes, financial institutions and lenders may be gravely disappointed.

The Real Solution: Buying Adjustable-Rate and Short-Term Loans on the Loan Market

An increasing number of bankers have been re-evaluating their asset sensitivity and the loan market as a result of the unpredictability regarding the anticipated interest rate increase, and so they should.

Banks need to focus on adjustable-rate or short-term loans amidst higher interest rates.

The real solution to boosting profits and reducing costs is not just to hope for a rise in interest rates, but to revamp loan portfolios so that a larger proportion of them are dedicated to adjustable-rate and short-term loans.

When the money that banks lend out is tied up in long-term loans, like mortgages, they risk losing money if there is an unanticipated discrepancy between long-term and short-term interest rates. And with long-term interest rates set to increase at some point in the near future, capital loss is possible if they continue to lock in to such long-term loans.

Amid this impending interest rate hike environment, many savvy bankers and lenders have been adding adjustable rate loans (such as auto loans) and shorter-term assets to their current holdings. Without being locked into a long-term, low-interest loan, banks stand a better chance of capitalizing on earning potential when rates rise. When banks hold an adjustable-rate or short-term loan, necessary losses can be avoided and profits can be realized.

Financial institutions that are contemplating the purchase of these types of assets would be well-advised to speak with the professionals at Garnet Capital, an experienced and long-standing loan sale advisory team which can make such loan acquisitions possible.

To find out more about how we can help you diversify your loan portfolio to bring in more revenues for your lending institutions, contact Garnet Capital today.