Strategy

Incredible Shrinking Bank Margins

Another reason some banks aren't too keen on lending? They're not earning much profit off it.
Vincent RyanAugust 11, 2011

Bank CFOs didn’t groan publicly when the Federal Reserve’s Open Market Committee voted to leave the Fed funds rate at essentially zero until mid-2013. But it couldn’t have been good news. One of the principal reasons U.S. commercial banks (especially on “Main Street”) are in such poor financial shape is lower interest rates. Indeed, it’s a factor contributing to the slow growth in overall bank lending.

Since the Fed started its drastic cuts to the funds rate in the spring of 2008, banks watched their net interest income slide then fall drastically. Net interest income (NII), of course, is the difference between what a bank borrows money at (interest expense) and the price at which it lends that money (interest income). 

CFO Insights on Inflation, Workforce Challenges, and Future Plans 

CFO Insights on Inflation, Workforce Challenges, and Future Plans 

Download our 2022 survey report for a high-level view of finance team projections and strategies, directly from our CFO.com executive readers.

At first the spread wasn’t so bad, but now that more consumer and business loans have been repriced at very low rates, and banks are at a “hard bottom” on the deposit interest they pay, NII has cratered.

Data analysis obtained from Capital IQ shows that in the past three years (as of the second quarter) NII at 19 of some of the 30 largest banks in the U.S. fell by 15% on average. (The media was a dip of 12.4%.) That’s a neck-wrenching reversal from the three-year run-up to 2008, when NII for those banks rose 53.7% on average.

CIT Group, Deutsche Bank and Trust Company, Morgan Stanley Bank, RBC Bank (USA), and First Horizon National had the largest drops. Some of these financial institutions tend to be “asset sensitive”—their assets are more likely to be investment securities and other short-term instruments, so their net interest margins get hammered when interest rates decline.

But the data show that banks that do the bulk of their business in consumer and business loans—like TD Bank, Regions Financial, Sovereign Bank, and Comerica–have also suffered.

Low deposit rates and net interest margins make it difficult to support the cost structure associated with capital-intensive bank branch networks, says Richard Speer, chief executive of bank consultancy Speer & Associates. “If your money yields half a percent, it’s hard to justify a branch network that might cost you 2%.”

The gloomy math is creating the appetite for credit card receivables, which have significantly broader net interest margins, says Speer. Capital One recently bought a $30 billion credit card portfolio from HSBC. Regional banks are also re-entering the credit card issuing business, after jettisoning those loans the last 20 years. “It’s a core [client] relationship and a nice profitable operation if a bank runs it well,” says Speer.

While banks don’t generally make much money on large commercial and industrial loans, the net income from lending is not helping the more typically profitable loans to midsize and smaller businesses. The good borrowers aren’t borrowing, says Speer, and the less creditworthy were hit hard by the recession. If a bank isn’t going to earn a big spread from a risky borrower, it doesn’t pay to lend at all.

So the Fed’s year commitment to low interest rates until 2013 will cost banks dearly—unless they can find other ways to earn more interest.

4 Powerful Communication Strategies for Your Next Board Meeting