Big banks were looking great about a month ago, just before the Federal Reserve meeting in September. However, after recent comments by the Federal Reserve with regard to the coming rate hike, big banks like Bank of America and Citigroup are having a rough time in the market. Today, we’ll talk about how the Federal Reserve’s interest rate affects banks, what we heard from the Federal Reserve, and what we can expect from BAC and C moving forward. So, let’s get right to it…
What Do Big Banks Have To Do With The Federal Reserve Interest Rate?
When thinking about profits for banks like Bank of America and Citigroup, what is the first thing that comes to mind? If you’re like most, you’re thinking about loans. One of the biggest revenue drivers for these banks is the interest that consumers and businesses pay on loans. To borrow this money from the Federal Reserve, the banks have to pay the Federal Reserve’s interest rate. So, in order to earn a profit, these banks add a markup to the Federal Reserve’s rate; that markup turns into revenue for the banks! This is why big banks and big bank investors want the Federal Reserve to increase its rate.
In general, big banks charge a percentage markup on the Federal Reserve’s rate. So, the lower the Federal Reserve’s interest rate is, the lower the margin for the banks. Adversely, when the Federal Reserve increases its rate, the margin banks earn on loan interest rises leading to higher profits.
What We Heard From The Federal Reserve
The Federal Reserve has been planning to increase its interest rate by the end of the year 2015. However, that doesn’t seem like it’s going to happen anymore. In fact, it’s possible that the current rate of 0.25% will be reduced sometime soon. The Federal Reserve is concerned that worldwide economic concerns are going to lead to economic problems here in the United States – and for good reason. The reality is that the United States economy, like any other economy around the world, is closely tied to other world economies. That’s because of the free trade environment that has created what’s known as the global economy. Essentially, if big players in the global economy struggle, consumers in the countries that are struggling aren’t going to be as willing to pay for American made products. This will take a heavy toll on the United States economy.
While 0.25% is a record low interest rate for the United States, the Federal Reserve is actually considering a negative interest rate to avoid future economic complications. Here’s what William Dudley, president of the New York Federal Reserve had to say on Friday…
“We decided – even during the period where the economy was doing the poorest and we were pretty far from our objectives – not to move to negative interest rates because of some concern that the cost might outweigh the benefits… Some of the experiences suggest maybe we can use negative interest rates and the costs aren’t as great as you anticipate…”
What This Means For Big Banks Moving Forward
Moving forward, I’m expecting to see more bearish movements out of US bank stocks. The reality is that investors were banking on the idea that the Federal Reserve was going to increase interest rates. Now that the Fed is considering negative interest rates to avert the next economic crisis, those expectations have been thrown out of the window which will likely lead to more declines.
What Do You Think?
Where do you think big banks like BAC and C are headed and why? Let us know in the comments below!
[Image Courtesy of Forbes]