If even US banks are worried, spare a thought for the rest…
ref: - "Return to Easy Money Poised to Slam Bank Profits in US, Europe “, Bloomberg Markets
Did they say "RETURN to easy money”? People outside of the States and particularly in Europe and Japan would argue without fear of contradiction that easy money's never gone away. Global considerations may have caused the US Federal Reserve to delay their intended rate-rising cycle a couple of times in the early days, but they have still managed no less than nine rate hikes since 2015. That at least gives the central bank some firepower when they decide that an easier monetary policy is appropriate (more on that in a second...).
But in the Eurozone, where the deposit rate was lowered to MINUS 0.4% way back in 2014, we have not really seen a very cautious ECB even being close to getting started on a hiking cycle. They have stopped their bond-purchasing QE programme, but have not seriously yet considered reducing their balance sheet of bond holdings acquired through QE… a move that would constitute an active form of tightening policy, rather than just an end to further easing
And now? All the momentum is headed the other way, of course. The ECB meet on Thursday, and while no immediate action is anticipated they are fully expected to signal either further rate cuts or a resumption of QE, or most likely both, in September. It is also as close to certain as you can get that the US Fed will cut rates next week, the only question is by how much. Futures prices suggest that 25 basis points are more likely than 50bp, and they also point to a total of 75bp in cuts by year-end.
On one level lower rates are of course a stimulus for an economy, but when we get down to ultra-low or even negative rates, they come with dangers attached. A healthy banking system is fundamental to a healthy economy, and lower rates are bad news for banks. They reduce the profit margins on bank lending. Bloomberg relates the old dig at US bankers about borrowing money from their depositors at 3%, lending it out at 6% and being on the golf course by 3 p.m.; not any more… NIMs (Net Interest Margins) are not what they used to be and are headed in the wrong direction. US bank earnings numbers released last week by the likes of JPMorgan Chase and Citigroup highlighted this last week, and that's before the Fed have even officially begun to cut rates.
If it's a worry for banks in the US, imagine then the position of banks in Europe and Japan where rates have already been not just low but negative for years (2016 in Japan). According to Jan Schildbach of Deutsche Bank, further easing in the US will impinge on bank revenue and profit growth, whilst in Europe, it will be a more painful experience. Negative rates mean that at the short end of the maturity scale banks actually have to pay to lodge overnight money with the central bank but can't pass that cost on to their customers who would be more likely to withdraw money from the financial system (the old "keep it under the mattress" scenario) than to pay for the privilege of effectively lending their money to the banks.
As short-term rates are whittled down, so that affects longer-term yields that have already been pressurized by the QE bond purchasing programmes. That, in turn, reduces the margin that banks can make on mortgages, corporate loans and other forms of debt. It stills seems a little surreal to many but the fact is that there is over $13 trillion in global bonds that return a negative yield. Yield curves have been flattening (the premium of long-term rates over short-term has been reducing). That means that safe-haven hunting, QE and a lack of inflation have been depressing bond yields even when the Fed was raising short-term rates, and now that tightening is likely to reverse it's only going to hurt bond yields further. Since most bank lending is at the longer end, that reduction in NIM is not going to do much for profitability either.
We might see a slight steepening of the US yield curve as the Fed starts on a path of cutting rates. That would be better news for banks... flat yield curves remove much of the opportunity to capitalise on another traditional pillar of bank profitability, making a turn on "borrowing short and lending long". Curve steepening would also lessen the danger of the curve properly inverting (short rates higher than long). Parts of the curve have already done so, and since inversions are often viewed as fairly reliable precursors of recession then anything that reduces the chances of that event coming to pass must be good for confidence.
You know, in theory, one could argue that low rates are good for banks as well. They should increase the demand for loans, and thus the higher turnover offsets the damage that smaller margins due to net interest income. In practice, it doesn't necessarily work that way. Low rates do not always translate into the boost to demand desired, or they take a long time to do so by which time the banks have already taken a hit.
Anything else? Oh yeah... the new regulatory environment demands that banks must hold increased levels of easy-to-sell instruments to comply with global liquidity requirements. You find such suitable instruments mostly in the government bond markets, much of which in the Eurozone (Germany, France, Netherlands etc) is trading in negative territory, yield-wise. So, in other words, as well as having to pay the ECB to lodge excess short-term funds with them, banks are also obliged to hold longer instruments that might also cost them a pretty penny or two.
Well, nobody said it was easy... not recently, anyway.