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Fed NIM Assessments

Stijn Claessens (FRB), Nicholas Coleman (FRB), and Michael Donnelly (FRB), Federal Reserve, IFDP Notes, “Low-for-long” interest rates and net interest margins of banks in Advanced Foreign Economies, April 2016, here. Mostly Macro observations. I am guessing COF runs some basic LP optimization for their capital plan implementation. They have some capacity to evaluate external portfolios like GE Capital’s Loan portfolio to get a price they (COF) can justify vs. what GE Capital was asking.   Maybe they can do something like price cashflows on an expected basis for M&A activity. The FED folks are locked in on Macro issues in these publications. It is interesting but I think COF is tighter to the actual game being played.

Since the global financial crisis (GFC), interest rates in many advanced economies have been low and in many cases are expected to remain low for some time. Low interest rates help economies recover and can enhance banks’ balance sheets and performance by supporting asset prices and reducing non-performing loans. But persistently low interest rates may also erode the profitability of banks as low rates are typically associated with lower net interest margins — NIMs, typically measured as net interest income divided by interest earning assets. While overall advanced economies’ bank profitability, measured by return on assets, has recovered from the worst of the GFC, it remains low and many advanced economies’ banks are facing profitability challenges, related to low net interest margins as well as weak loan and non-interest income growth. And while NIMs across many advanced economy banks have been trending down on a longer-term basis, they have fallen more sharply since the GFC, in part, as appears so, on account of lower interest rates.

David Wheelock, St Louis Fed, Are Banks More Profitable When Interest Rates Are High or Low? May 2016, here.

The period since 2010 has been somewhat unusual in that net interest margins have continued to fall while the yield on one-year Treasury securities (and other market rates) has been relatively stable at historically low levels. Over this period, bank funding costs have been exceptionally low, but the average rates of return on bank assets have continued to fall. Loans made in the past at relatively high interest rates have been replaced by new loans with lower interest rates as well as by low-yielding reserves and securities.

For more information and analysis about the recent behavior of net interest margins, see the articles “Why Are Net Interest Margins of Large Banks So Compressed?”1 and “Do Net Interest Margins and Interest Rates Move Together?”2

Dean Anderson, Federal Reserve Atlanta, ViewPoint: Spotlight: Net Interest Margin Performance, here.

This scenario will undoubtedly present challenges for banks in managing their net interest margins. One potential remedy could be increased use of non-interest liabilities, which have been on the rise over the last few years because of heightened depositors’ risk aversion and economic uncertainties. However, this strategy presents potential issues, as those funds could easily be withdrawn once depositors become more confident in any economic recovery. Another solution may be to increase net interest positions further, yet it is doubtful that such an increase will provide much support for net interest margin and could also present potential risks should interest rates rise and the composition of interest-bearing liabilities favor shorter-term over longer-term maturities.
Historically, capital has been used to help fund earning asset growth, especially when rates were rising, yet the cost of equity—the required return demanded by investors—is higher in the current environment than in the past, so attracting investors when returns are so low is unlikely. Finally, a boosting of yields would be one of the most direct ways to increase net interest margins, but finding yields that provide an adequate risk/return profile has been difficult for most banks.
Because there seem to be limited solutions to boost net interest margin in a continued low-rate environment, does this then mean there is a paradigm shift in the reliance on net interest margin to fund bank operations? There is no clear-cut answer to this question, as data on how banks manage net interest margins and overall revenues in a multi-year, near-zero interest rate environment are nonexistent. However, what history does tell us is that banks find ways to adapt to the environments they operate in ways that are hard to predict. So whether it’s the creation of new interest rate products or fee-generating services—or if rates simply rise and net interest margins expand as a result of increasing yield/cost spread—a healthy, profitable banking industry is important and necessary to help fuel economic growth.

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