Interpretation Of The Relationship Between Market Interest Rate And Net Interest Margin

Banks are more profitable when market interest rates are higher or lower? In response to this question, David Wheelock, deputy director of Saint Louis fed research, wrote that the trend of net interest rates in the short run is opposite to market interest rates in the short term, but in the medium to long term, the net interest margin is largely independent of the overall level of market interest rates.

We usually believe that banks prefer higher interest rates, and when banks have higher interest rates on loans and other investments, their incomes may be higher.

However, banks must raise funds for their investment, and when the market interest rate is high, the financing cost of banks is generally higher.

He mentioned that most banks obtain funds for loans and other investments by issuing bonds (mainly depositors' deposits), but they can also raise funds in the open market through various bonds.

When market interest rates rise, bank financing costs also increase.

Therefore, the effect of higher interest rates on net interest spread (interest rate differential between banks and interest expense) is not clear.

David Wheelock explains that these two curves have been down for several years, but in the short term, such as one year or two years, the trend of net interest rate is opposite to market interest rate.

For example, during the -2009 recession of 1990-1991, 2001 and 2007, the decline in US Treasury bond yields coincided with a significant increase in net interest margin.

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After that, market interest rates begin to decline, and net interest rates will eventually decrease.

However, as time goes on, when the loan is lower,

After being repaid and updated, the net interest margin declined.

Therefore, in the medium to long term, net interest margin is largely irrelevant to the overall level of market interest rates.

David Wheelock pointed out that this period of time has been unusual since 2010, because the net interest margin has continued to slide, while the one year treasury bond yields (and other market interest rates) have remained relatively stable in historical lows.

During this period, the cost of bank financing was very low, and the average return on bank assets continued to decline.

In the past, bank loans with relatively high interest rates have been replaced by new loans with lower interest rates and low yield bank reserves and securities.

David Wheelock said that to understand the relationship between market interest rate and net interest rate, the key is to understand that banks usually borrow short.

That is to say, the average maturity of loans in bank portfolios often exceeds the average period of bank deposits and other debts.

Therefore, when market interest rates fall, the cost of bank financing usually decreases faster than the interest income earned by lending or other investments, resulting in a rise in net interest margin.