But they also … New England Patriots coach Bill Belichick turns down Trump medal: report, Bank earnings will be ‘mixed’ and ‘messy’—but there’s some good news, Moderna to develop vaccine candidates for seasonal flu, HIV, Nio to offer $1.3 billion in convertible notes, Pence and Trump spoke Monday evening for first time since Capitol riot, White House official says, Why an Elon Musk tweet led to a 5,675% surge in Signal Advance’s stock, What investors should know about the cannabis market in 2021, Walt Disney World is eliminating these popular perks for hotel guests. 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. While an inverted yield curve has frequently been a harbinger of a recession, sending stock investors running for the hills, a steepening yield curve can signify the opposite, which is good … It is worth remembering that the results are driven by the average maturity and composition of assets and liabilities of bank balance sheets. 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. XLF, The final observation. Frank Eich works in the Bank’s International Surveillance Division. Summary. 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). The yield … And the flattening of the yield curve … But even this latter relationship has weakened since the global financial crisis. Equities tend to trend downward for first half of yield curve steepening. In other words, only medium term rates will change? The yield curve’s beneficial impact on bank margins passes for conventional wisdom, the researchers said. 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. While, for the most part, higher long-term rates have juiced earnings. Sources: World Bank, OECD, SNL and Bank calculations. Meanwhile, the slope of the yield curve is defined as the difference between the long-term interest rate (10 year government bond) and a short-term rate. As long-term rates tend to sit higher than their short-term peers, banks take advantage of the difference by lending “long” and borrowing “short” (see chart lower). In light of this caveat it is hard to say with certainty whether this observed relationship between long rates and NIMs will reinstate itself or not; it is too early to tell. Using data for a panel of 10 countries over four decades, we find no systematic positive relationship between the slope of the yield curve and bank net interest margins. That creates the possibility of the yield curve steepening at the very same time banks attempt to break out of their range. 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. Copyright © 2021 MarketWatch, Inc. All rights reserved. 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. 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. Instead, we find that long-term interest rate tend to drive bank margins. 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. Likely too early to expect a bottom on the S&P 500. 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 net interest margin is the difference between the interest banks earn on the loans they make and the interest they pay to savers. Market Overview Analysis by Sober Look covering: BP PLC, Total SA, SIMPLE SA. 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. TMUBMUSD10Y, It’s a widely held belief among policy makers and investors that banks benefit from a steeper yield curve by taking advantage of the spread between short- and long-term interest rates. 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. 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. 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. Net interest margins are calculated as the interest banks earn on their assets—e.g. “A steeper yield curve is unequivocally good for banks,” said Doug Foreman, chief investment officer at Kayne Anderson … Similar principles apply to building societies and many other financial intermediaries. This post was written whilst Oliver Brenman was working in the Bank’s Policy and Strategy Division. from deposit accounts) and lending long term (e.g. This activity is typically profitable as short-term interest rates are usually lower than long- term interest rates. One penultimate observation. Member, Association of Corporate Treasurers; Member, Society of Professional Economists, Independent Economic and Treasury Advisor. 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. But notice in the top chart above that the relative strength ratio peaks at the same time as the 10-2 spread. 1. Oliver Brenman, Frank Eich, and Jumana Saleheen. 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. However, a very simple plot of the slope of the yield curve and the NIM does not deliver a positive relationship (Figure 2). Back then, the spread between the 10-year yield The logic being “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 researchers said. The short rate is closer to zero and is insignificant for most countries, apart from Italy and Spain. The conventional wisdom amongst financial market observers, academics, and journalists is that a steeper yield curve should be good news for bank profitability. A very steep yield is normally associated with an eventual significant slowdown in the economy, as the monetary authorities aggressively tighten monetary policy. 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. 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 In this environment, the level of mainstream business activity steadily increases, whilst a competent bank treasury should make significant profit from prudent investment in long dated fixed rate bonds (normally high grade government or corporate bonds). So it is really a steepening yield curve that is good for small cap outperformance, not just a steep one. From a bank profitability viewpoint, the slope of the yield curve can often be a more significant, longer term, than the level of long -term rates. 0.148% Are you saying that the yield curve will steepen without the LT rate going up? 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. The conventional wisdom follows from  banks’ fundamental business model— to act as maturity transformers by borrowing short term (e.g. If you want to get in touch, please email us at bankunderground@bankofengland.co.uk or leave a comment below. Sorry, your blog cannot share posts by email. Another important factor is prudential policy – notably the requirement to maintain an adequate level of liquidity. Post was not sent - check your email addresses! Jumana Saleheen works in the Bank’s Financial Stability, Strategy and Risk Directorate. This article challenges that conventional wisdom. 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? 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. This could reflect changing bank business models or simply the shifting composition of securities on a bank’s balance sheet, they said. Listen to What Does A Steepening Yield Curve Mean And How Do Investors Generally Interpret It? 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