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 spread. 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 … For example, NIMs also reflect the rewards banks collect for bearing different types of risk (e.g. Instead, we find that long-term interest rate tend to drive bank margins.   and its shorter-term peers were negative. Such an environment is normally associated with a slowdown in the level of UK business activity, in response to both actual and anticipated monetary policy tightening. Even as longer-term Treasury yields plummeted as investors focused on the return of principal (as opposed to return on principal), the Federal Funds rate dropping by 150 basis points led to a steepening of the yield curve. Figure 3: UK banks’ net interest margins and the long-term interest rate have historically moved closely together but the relationship appears to have weakened post financial crisis. In the example, a bank issues a loan at 3.5%, matched with bank deposits of shorter maturities offering an interest rate of 1%. “We believe the continued weakness of … 2. 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 amongst financial market observers, academics, and journalists is that a steeper yield curve should be good news for bank profitability. 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). from deposit accounts) and lending long term (e.g. But notice in the top chart above that the relative strength ratio peaks at the same time as the 10-2 spread. Stemming from this understanding of maturity and liquidity transformation Bill English  observes that this intuitive positive relationship has been the conventional wisdom for some time.  can live or die by the curve’s fluctuations. But they also … The title of one of my professional bodies has very recently changed to The Society of Professional Economists. This activity is typically profitable as short-term interest rates are usually lower than long- term interest rates. This post was written whilst Oliver Brenman was working in the Bank’s Policy and Strategy Division. The views expressed here are those of the authors, and are not necessarily those of the Bank of England, or its policy committees. A challenge to the conventional wisdom, Montagu Norman and the transformation of the Bank, There’s more to house prices than interest rates, Global real interest rates since 1311: Renaissance roots and rapid reversals. 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. JPMorgan Chase & Co., in its latest quarterly filing, said a steeper yield curve would boost interest income by $1.7 billion while a flatter one would lead to a $2 billion increase. Figure 1 illustrates this with the aid of a stylised yield curve. Figure 3 shows that while that relationship held in the UK prior to the financial crisis, it appears to have broken down since – as the NIM has flattened out in recent years, despite the continued fall in the long rate. Net interest margins are calculated as the interest banks earn on their assets—e.g. Sorry, your blog cannot share posts by email. 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. 1. While, for the most part, higher long-term rates have juiced earnings. This would give relief to banks suffering from the weight of low interest rates in the hope that stronger banking activity would stimulate the broader economy. Yes, banks outperformed the S&P 500 by 82 percentage points from 2000 to 2004 and by 73 points from 1980 to 1986, periods when the yield curve was steepening. This finding helps to explain why an upwards parallel shift in the yield curve is good for net interest margins (because while the slope does not change the long rate goes up). 1.153%. As part of its corporate update, Moderna said it had about $5.2 billion in cash as of Dec. 31, compared to the $1.2 billion in cash it had at the same time a year ago, and it expects to generate at least $11.7 billion in revenue in 2021 for its COVID-19 vaccine based on advance purchase agreements. "The uniquely challenging year of 2020 for all of society proved to be an extraordinary proof-of-concept period for Moderna," CEO Stéphane Bancel said in a news release. Some central banks, such as the Fed and the Bank of England, have started the tightening phase of monetary policy, which has been associated with a steepening of the yield curve. Given this, bank … Our results suggest that it is the level of long-term interest rates, rather than the slope of the yield curve, that drives banks’ NIMs. If the structure of their balance sheets changes, so too might these results. Click to share on Twitter (Opens in new window), Click to share on LinkedIn (Opens in new window), Click to share on Facebook (Opens in new window), Click to email this to a friend (Opens in new window), Click to share on Pocket (Opens in new window), Click to share on Reddit (Opens in new window), Click to share on Tumblr (Opens in new window), Click to share on Pinterest (Opens in new window), Is a steeper yield curve good news for banks? In the wake of the COVID-19 pandemic, financial markets experienced almost unprecedented levels of volatility during the month of March. In my lengthy experience of treasury management, international factors (especially the consensus forecast path of the US and Chinese economies) are significant drivers of longer-term sterling fixed interest rates. The commonly held view is that such a steepening of the yield curve should be unequivocally good news for bank profitability because it raises banks’ net interest margins. Motivated by this discovery, we sought to inspect how the individual components of the slope of the yield curve (the short and long rate) affect NIMs. Figure 1: Illustration of maturity transformation. on the loans they make — minus the interest they pay out on their liabilities – e.g. This reflects an attempt to widen the scope of economic debate, by increasing the potential for links between business economists and those working in other fields, notably the academic and government sectors. Oliver Brenman, Frank Eich, and Jumana Saleheen. A steeper yield curve is a bank investor’s new best friend - The Globe and Mail A steeper yield curve is a bank investor’s new best friend David Berman Investment Reporter Published … But new research from the Bank of England shows it isn’t the slope of the yield curve as much as long-term rates on government bonds that dictates a bank’s net interest margins, a key driver of their profitability. So if the yield curve steepens, bank profits should rise. Similar principles apply to building societies and many other financial intermediaries. 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. The yield curve is a graph showing the bond yields of various maturities ranging from 3-month T-bills to 30-year T-bonds. It is worth noting that we wouldn’t expect this theoretical relationship, between the slope of the yield curve and NIMs, to hold perfectly in the real world. And the flattening of the yield curve … The yield curve’s beneficial impact on bank margins passes for conventional wisdom, the researchers said. A very steep yield is normally associated with an eventual significant slowdown in the economy, as the monetary authorities aggressively tighten monetary policy. In other words, only medium term rates will change? For example, NIMs capture much more than just the gains of maturity transformation. When the yield curve is steep, banks are able to borrow money at lower interest rates and lend at higher interest rates. The graph is plotted with … TMUBMUSD10Y, This article challenges that conventional wisdom. Longer term sterling rates are determined by a number of factors, notably the expected path of sterling bank rate, and the expected path of the both the UK and global economy (and hence fund manager asset allocation between fixed interest securities and equities / other investments). 4. Market Overview Analysis by Sober Look covering: BP PLC, Total SA, SIMPLE SA. Sources: World Bank, OECD, SNL database and Bank calculations. The benchmark 10-year yield US10YT=RR, which climbed as high as 1.125% for the first time since March, was last up 4.4 basis points at 1.1153% and the yield curve steepened. The yield curve, a line tracing yields across bond maturities, measures the difference between long-term interest rates, such as the two-year Treasury note Comments will only appear once approved by a moderator, and are only published where a full name is supplied. These changes no doubt will have some impact on the slope of the yield curve and its relationship with NIMs, but those are beyond the scope of this article. 2020 hindsight: what can supervisors learn from the collapse of Barings Bank 25 years on. A yield curve is simply the yield of each bond along a maturity spectrum that's plotted on a graph. Post was not sent - check your email addresses! Michelle Martin and Ryan Huang discuss the steepening US yield curve, renewed interest in Singapore banks, OCBC appoints a woman CEO, CDL's shares, Apple, Google and Amazon, stimulus in the US and … “In the short term, banks can outperform on the yield curve steepening that should accompany any further post-pandemic return-to-normal trade,” Chris Wood noted. This is beyond the remit of this article. The secular bond bear market starting from 1980 saw long-term bond yields fall across the globe but net interest margins stabilized after the 2007-2009 recession. Sources: World Bank, OECD, SNL and Bank calculations. It provides a clear, visual image of long-term versus short-term bonds at various points in time. Figure 4: Post crisis bank net interest margins have remained remarkably stable, despite significant falls in interest rates. Even with the Federal Reserve expected to keep interest rates low, the yield curve has been steepening as investors try to look beyond the pandemic. Figure 2: Simple plot of the slope of the yield curve and average bank NIMs in the United Kingdom. After the financial crisis, the link between higher long-term interest rates and strong bank earnings appeared to break down, the researchers said. Equities tend to trend downward for first half of yield curve steepening. The paper raises a number of important points, and the following observations may be of relevance. If not, then how can the yield curve steepen without LT rates going up? Sources: World Bank, OECD, SNL and authors calculations. "In the short term, banks can outperform on the yield curve steepening that should accompany any further post-pandemic return-to-normal trade," Chris Wood noted. Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. That’s why stock analysts say financial shares This suggests there is much uncertainty about the future relationship between interest rates and bank profitability. In this post, we present cross-country evidence that challenges this view. 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. Listen to What Does A Steepening Yield Curve Mean And How Do Investors Generally Interpret It? Indeed Table 1 (below) shows that this negative relationship arises in all countries in our sample bar the US, a point observed by a Liberty Street Economics blog post. The views expressed here are those of the authors, and are not necessarily those of the. through mortgages or loans to companies). Likely too early to expect a bottom on the S&P 500. However, a very simple plot of the slope of the yield curve and the NIM does not deliver a positive relationship (Figure 2). What do these findings tell us about the past and the future? The yield curve’s beneficial impact on bank margins passes for conventional wisdom, the researchers said. The impact of these factors diminishes as the economy slows in response to significant monetary tightening. 3. 0.148% But the researchers at the U.K. central bank found a steepening yield curve was, in fact, more closely linked to a fall in the net interest margins, although the U.S. was the one exception to that rule (see chart lower). Sunny Oh is a MarketWatch fixed-income reporter based in New York. It is worth noting that in recent decades the countries in our sample have been through large economic, structural and policy changes, such as the introduction of inflation targeting, and changes in competition, financial liberalisation and regulation. This may be because of the large macroeconomic and financial shocks that affected banks, or because banks have changed their business models and the structure of their balance sheets. The conventional wisdom follows from  banks’ fundamental business model— to act as maturity transformers by borrowing short term (e.g. The short rate is closer to zero and is insignificant for most countries, apart from Italy and Spain. Firstly, it is encouraging, from a prudential viewpoint, to read that the Bank of England is conducting in depth research into the impact of a steeper yield curve. 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