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Why It’s Too Soon For Banks To Celebrate


The last year there had been so much talk about whether interest rates would go up, when they would go up, how much they would go up, and what the impact of any increase would be.

In December, the Federal Reserve put the crystal ball gazing to rest when it raised the target rate for the federal funds rate to one quarter to half a percent. It was seen as the first step in an upward march that would extend into 2016.

While on the one hand, a rate hike was viewed as a sign that the economy perhaps was finally strengthening, consumers felt no reason to rejoice, mostly because they anticipated higher interest rates would hit them squarely in the pocket - be it credit cards, mortgages or car loans, and savers didn’t feel overly confident that the interest earned on their savings would improve significantly.

But higher interest rates are music to bankers’ ears.

"With a lower interest rate, there is normally a decrease in the net interest margin, so a lot of banks are actually hoping for an interest rate increase. An interest rate hike is usually a sign that the economy is doing well, which can translate into higher demand for consumers and even business loans, which also improves profits," explains David Bakke, a financial journalist with

Truth is, banks’ net interest margins mostly have been nothing to brag about with the low, low interest rates of recent years and other factors. Net interest margins are the spread between a bank’s borrowing costs and lending rates. When this difference shrinks, bank profits suffer. It is estimated that bottom-of-the-barrel rates put a damper on bank margins by more than 27% over the last six years.

But rising rates don’t necessarily mean it’s time for banks to start celebrating.

"As a result of near-zero low interest rates previously, many consumers purchased homes using adjustable rate mortgages and banks gave their fair share of these loans. The problem is that as the Fed increases its interest rates, the interest on these mortgages climb as well. This increases the mortgage payments and makes it harder for consumers to fulfill their obligations. We may see foreclosures rise, which will again hit the banks," says Idan Levitov, vice president of trading at

Furthermore, Levitov says, with higher interest rates, the cost of anything rises and demand for the product declines. In the case of banks, demand for mortgages, auto loans and other loans will likely decline.

"While the banks may make more money on loans with higher interest rates, the amount of loans they are likely to supply is going to decline. So essentially, the gains from higher interest are washed out by the lower number of loans that are likely to be taken out. As a result, the banks have been experiencing relatively flat movement, which will only trend downward if interest rates rise further," he predicts.

The news is sobering still, as the Fed left rates unchanged in January, clearly cooling its heels, after eyeing all the political and economic turmoil around the globe.

As for what the Fed will do come March, who knows? Maybe there will only be two rate hikes this year instead of four. Looks like we’re back playing the guessing game.

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Anonymous   |     |   Comment #1
And Penfed already ened their 15 month CD promo.  It is now 1.26%
Anonymous   |     |   Comment #2
The FEDs got reminded by the Treasury, what are you trying to do bankrupt the country, we can not even pay the 0% treasury bills and borrowing from China to pay not the interest but the shortages of the current treasuries, well, you can figure out the rest.
Anonymous   |     |   Comment #3
As news spread of NIRP being instituted by the Bank of Japan the markets celebrated. Wall Street and the banks have grown hooked on easy money and can't kick the habit. The Fed may have learned it's lesson not to upset the apple cart as one and out may be the story of any rise in rates.
Anonymous   |     |   Comment #4
The stock markets of the world are going down. People are flerong to safe investments like treasuries. This is causing rates to go down. Yes the Fed can manipulate intrest rates bit so can other factors.
Anonymous   |     |   Comment #5
Treasuries are safe?  Don't be holding one when this Ponzi game reaches its termination.
Anonymous   |     |   Comment #8
In financial terms they are considered safe. Are CD's safer than treasuries if it is the government insuring them?
Anonymous   |     |   Comment #9
You can not protect the purchasing power of the dollar no matter where you put your money. There is to much money floating around the globe, 90% of all nations have deficits and must print or borrow or create money from something to pay for the freeloaders and the socialist programs.
Anonymous   |     |   Comment #6
I'm sick of these idiot "experts" telling people to get only short term cd's......Why? Rates are only going to start going down. My advice is find the highest rate regardless of the term and lock it in. LOCK IT IN!!!!!!   NOW!!!!!!!  Rates will NEVER be allowed to rise .......DO IT NOW!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!
Anonymous   |     |   Comment #11
"I'm sick of these idiot "experts"......

You sound just like one of them yourself.
Anonymous   |     |   Comment #7
There is a 0% chance of any further rate increases this year.........0%........We will soon have negative rates here or they will just confiscate deposits like they did in Cyprus.
Anonymous   |     |   Comment #12
Who's "they"?

It's likely your understanding of what happened in Cyprus is muddled.

Neither do you probably realize that "negative rates" as instituted by Central Banks in Europe and Japan don't apply to public deposit accounts.
Anonymous   |     |   Comment #13
Negative rates are an intentional effort to weaken your own country's banks. Negative rates are a punitive command: go out there and make more bad loans where risk is entirely uncompensated, or we will, in effect, fine you. The more bad loans you don't make, the bigger the fine. Negative rates are only a bit worrying in today's sputtering economies of Europe, Japan, and the US because the credit cycle has yet to completely roll over. But it is rolling over (read anything by Jeff Gundlach if you don't believe me), it is rolling over everywhere, and when it really starts rolling over, any country with negative rates will find it to be significantly destabilizing for their banking sector. There's a reason that the Fed kept paying interest on bank reserves even in the darkest, most deflationary days of the Great Recession. Yes, it's the Fed's job to support full employment. Yes it's the Fed's job to maintain price stability. But the Fed's job #1 -- the reason the Federal Reserve was created in the first place -- is to maintain the stability of the banking system. Go ask a US moneycenter bank how things would have turned out in 2008 if the positive interest coming in on their reserves had been flipped to negative interest going out on their reserves. Go ask a US regional bank how things would have turned out if they had made even more rewardless risk loans in 2006 and 2007 under the pressure of negative rates. "
Anonymous   |     |   Comment #15
"Risky" loans hardly always turn out bad, and the fact of them being "entirely uncompensated" don't increase the proportion of those which do.  Monetary authorities have channeled unprecedented amounts of "free money" to their member banks, and are now simply nudging them to deploy these reserves for a productive purpose.  The result need not be "bad loans" but good loans that however small the return is still greater than negative.  As to "how things would have turned out in 2008..." perhaps many more good loans would have been made to stimulate the economy and we'd be better off now than we are. 

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