Here’s how US banks make money even with ultra-low interest rates.

Contrary to general opinion, not all banks in the developed world are suffering the effects of an ultra-low interest rate environment.

According to a discussion paper titled “QE and ultra-low interest rates: Distributional effects and risks” by the Mckinsey Global Institute (MGI), between 2007 and 2012, the overall net interest income of US banks increased by $85 billion, or 28%.

The net interest income is the difference between the interest paid on bank deposits and debt and the interest received on bank loans and other assets. This margin adds to the net profit of the bank.

Clearly, the performance of American banks is streets ahead of their counterparts in Europe or the UK.

Look at the chart below.


So how are banks making more money here?

MGI offers two reasons:

Reason #1: US banks managed to slash the interest rate on current/checking and savings deposits to near-zero levels, while still being able to hold on to sufficient deposits.

“In fact, total deposits in US banks actually increased over this period, most likely due to a flight to safety in a volatile time for finance, as well as increased household savings,” the report notes.

Reason #2: US banks also managed to ensure that the interest received on loans declined by a smaller proportion – 180 basis points or so. (100 basis points make one percentage point.)

“US banks have also benefitted from the fact that they securitise the majority of their loans and earn fees from loan origination, rather than holding the loans on their balance sheets,” the report notes. “This reduces their overall sensitivity to interest rate changes.”

In a nutshell, depositors have seen their deposit rates slashed, while borrowers haven’t benefitted as much from rock-bottom interest rates.

In the middle, however, banks continue to fatten their profits. Even in the era of ultra-low interest rates.

[Image Credit]


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