Copyright © 2021 MarketWatch, Inc. All rights reserved. For example, NIMs capture much more than just the gains of maturity transformation. While, for the most part, higher long-term rates have juiced earnings. In the example, a bank issues a loan at 3.5%, matched with bank deposits of shorter maturities offering an interest rate of 1%. The report he cites … Meanwhile, the slope of the yield curve is defined as the difference between the long-term interest rate (10 year government bond) and a short-term rate. Many banks hedge long term interest rate exposure, thus matching their variable rate liabilities with variable rate assets (fixed interest assets hedged by interest rate swaps or more sophisticated hedging mechanisms). The argument goes that because banks borrow short and lend long, a steeper yield curve would raise the wedge between rates paid on liabilities and received on assets – the so-called “net interest margin” (or NIM). It provides a clear, visual image of long-term versus short-term bonds at various points in time. Frank Eich works in the Bank’s International Surveillance Division. 3. If you want to get in touch, please email us at bankunderground@bankofengland.co.uk or leave a comment below. credit risk). Figure 1: Illustration of maturity transformation. See: Bank earnings will be ‘mixed’ and ‘messy’—but there’s some good news. Banks “focused instead on the greater likelihood of Congress approving a big spending package to limit the economic pain from the pandemic, as well as a steepening yield curve, meaning a … And the flattening of the yield curve … Yet the yield curve argument is popular because it conforms with the understanding of how banks make money. A rise in long- term rates is good for banks short term, due to the factors referred to in the paper. A yield curve is simply the yield of each bond along a maturity spectrum that's plotted on a graph. Table 1: For most countries a steepening of the yield curve has historically been associated with a fall in the net interest margin, while higher long rates with an increase. This reflects the fact that depositors are generally willing to sacrifice returns because they value the liquidity of holding their money in cash rather than in an illiquid investment. In other words, only medium term rates will change? Instead, the slope goes the wrong way – it is negative for the UK confirmed by a simple regression – suggesting that an increase in the slope of the yield curve lowers the NIM. The impact of these factors diminishes as the economy slows in response to significant monetary tightening. So a steep yield curve is the most profitable condition for them. Sources: World Bank, OECD, SNL database and Bank calculations. As banks seek to borrow money at short-term rates and lend at long-term rates, a steepening yield curve will earn more on lending and pay less on deposits, thereby leading to a wider … The conventional wisdom follows from  banks’ fundamental business model— to act as maturity transformers by borrowing short term (e.g. Equities tend to trend downward for first half of yield curve steepening. Given this, bank … This isn’t just a UK phenomenon — NIMs in other countries have remained relatively stable since the global financial crisis too, despite falling long-term interest rates in these economies (Figure 4). While an inverted yield curve has frequently been a harbinger of a recession, sending stock investors running for the hills, a steepening yield curve can signify the opposite, which is good … Summary. Sunny Oh is a MarketWatch fixed-income reporter based in New York. The conventional wisdom amongst financial market observers, academics, and journalists is that a steeper yield curve should be good news for bank profitability. “A steeper yield curve is unequivocally good for banks,” said Doug Foreman, chief investment officer at Kayne Anderson … Yield Curve Steepened Now Since banks borrow money at short-term rates and lend capital at long-term rates, steepening of the yield curve bodes well for bank ETFs. From this we conclude that, when it comes to interest rates, the long-term interest rate (unlike the short-term interest rate and the slope of yield curve) has a substantial positive impact on bank NIMs. Also, OCBC's New CEO, CDL Shares And Signal and ninety-nine more episodes by Interviews, free! Oliver Brenman, Frank Eich, and Jumana Saleheen. Instead, we find that long-term interest rate tend to drive bank margins. We find that the long rate is more important than the short rate in determining NIMs in a very simple regression model. 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