September 19, 2022
The large wave of deposits that swept over the banking industry over the past two years began to slowly recede in the second quarter. Bank deposits are still more than $3 trillion above their pre-Covid trend level, so banks have not been in a rush to increase the interest they pay on those deposits. This has enabled them to expand their net interest margin quickly.
Bank stocks, however, have not benefited from the rising rate environment and have suffered along with the rest of the market this year. The benefits of higher interest rates have been offset so far by increasing loan loss provisions driven by new accounting rules which require banks to reserve against potential losses more proactively. As concerns of a potential recession have increased, banks have set aside more for potential losses even though current loan delinquencies remain at historically low levels.
Another headwind for banks is that many have added longer-term loans and securities to their balance sheets. Approximately 39.4% of the banking industry’s assets are in maturities greater than three years, which is up from around 35% before the pandemic and less than 30% a decade ago. This raises the potential for realized losses as rates rise and limits how quickly they can take advantage of higher rates.
A return to a more normal interest rate environment should ultimately benefit banks by widening the net interest margin they can earn on their assets. The journey to that point may just be a little bumpy.