The Fed’s tight monetary policy pushing interest rates at multi-year highs has helped big banks earn significant gains on customer deposits. But these gains may not last as interest rates are near peak and a recession is looming.
A rising interest rate environment is usually bad for households and businesses that borrow money. But it is good for banks as they benefit from rising “net interest rate spread.”
That’s the growing difference between what banks pay depositors and the interest they receive for investing that money in government securities like Treasury bills. For instance, before the Fed began hiking interest rates, banks would pay close to 0% interest on checking and savings accounts and earn less than 1% investing the funds in U.S. Treasury bills. In recent months, banks still pay close to 0% interest for deposits or, in some cases, close to 1% and collect close to 5% in Treasury bills.
That’s a much wider gap helping banks print money, as reflected in the fourth-quarter earnings reports released on Friday. For instance, JPMorgan’s net interest income soared 48% for the quarter from a year earlier.
“Banks managed to beat earnings targets today, despite a slowdown in overall deal activity such as home mortgage loans and initial public offerings,” David Donovan, EVP of Financial Services at the digital consultancy Publicis Sapient, told International Business Times. “JPMorgan Chase beat forecasts, reporting a better-than-expected quarterly profit on a strong performance. Profit rose 6%, and revenue jumped 18%. In addition, higher interest rates created more net interest margin, making the reserves they took against bad debt look reasonable.”
Still, banks face several headwinds that may close the window of printing money. One of them is that interest rates are peaking.at a time rising competition for funds is heating up, meaning a declining net interest rate spread.
Another headwind is the weakening demand for housing loans, as higher mortgage rates have taken their toll on the housing market. In addition, banks collect hefty fees in originating and servicing household loans to purchase homes.
Then there is the weakening of the U.S. economy, which could further depress the demand for mortgages. In addition, it will raise loan default rates both in the consumer and the mortgage market forcing banks to set aside more reserves to cover these losses.
Wells Fargo has already seen its earnings cut in half from the year-ago quarter due to a significant decline in its mortgage banking unit and the need to set aside reserves for potential loan losses. Citigroup faced a similar situation, though better than Wells Fargo, which also met regulatory problems.
“We’re seeing positive Q4 results for most of the banks, but pretty much all of them highlighted significant headwinds for success in 2023, including inflationary pressures and an impending recession,” David Keller, Chief Market Strategist at StockCharts.com, told IBT.
Anthony Denier, CEO of Webull, expressed similar concerns.
“They continue to battle inflation, Fed rate hikes, and worries about a slowing global economy,” Denier told IBT. “However, higher interest rates have brought in a lot more interest income, which has helped their bottom line, but they need to make provisions for larger loan losses if the economy slides into recession.”