June 19, 2017 / 2:15 PM / 2 years ago

COLUMN-U.S. banks aren't passing on higher interest rates to customers ... yet: McGeever

(The opinions expressed here are those of the author, a columnist for Reuters.)

By Jamie McGeever

LONDON, June 19 (Reuters) - U.S. banks are profiting from higher official interest rates by not commensurately increasing the rates paid out on deposits, giving them an income advantage over their European peers.

The question now is whether those margins - the widest in years - start to narrow if banks are forced to increase savings rates for customers. And if they do, will banks’ profits and share prices come under pressure?

The spread between U.S. commercial deposit rates and interbank Libor or official policy rates should, in theory, be thin. For most of the last quarter century it has been no more than 10 basis points either way although banks will try to ensure they retain some cushion.

That’s currently the situation with UK and euro zone banks. The spread between 1-month UK commercial deposit rates and 1-month sterling Libor is just 3 basis points, and the euro zone equivalent is 5 basis points.

Of course, neither the Bank of England nor European Central Bank is raising rates. Far from it. British rates are a record low 0.25 percent, as is the ECB’s deposit rate at minus 0.4 percent.

Money market pricing suggests neither will rise any time soon. So there’s far less scope for banks in Europe to take advantage of the widening spread between deposit and lending rates as is typically the case.

But the Federal Reserve is raising rates, and the U.S. commercial deposit/Libor spread has widened lock step with the four hikes since December 2015.

That spread is now over 100 basis points, the highest in 18 years. Barring a short-lived surge to 300 bps in mid-1999, it’s the widest in 30 years.

It should be noted that commercial deposits are not quite the proxy for wider bank funding they once were. California’s First Republic Bank, for example, funded around 30 percent of its book via commercial deposits in 2002. That’s now just under 10 percent.

But overall net interest margin - the broadest measure of the gap between the interest paid on deposits and the interest earned on loans - is still the widest in years for U.S. banks, even if not quite as historic as the commercial deposit spread.

According to BankRegData.com, the net interest margin across U.S. banks was 3.13 percent in the first quarter. That was the highest since 2014.

Analysts at RBC Capital Markets note that U.S. bank deposits currently stand at a record $13 trillion, in large part thanks to the Fed’s QE stimulus. They estimate that QE created between $1.6 trillion and $2.5 trillion of new bank deposits.

But as the Fed prepares to reduce its $4.5 trillion balance sheet, that will likely reverse. RBC expects U.S. bank deposits to shrink by $500 billion next year as QE is withdrawn, although the industry’s organic growth should more than offset that.

“Banks may be forced to increase deposit rates faster than expected in order to ‘stem the tide’,” they wrote in a note last week.


There are many reasons why U.S. banks have outperformed their European rivals recently, including: better cost control, stronger balance sheets, and expectations that President Trump would boost growth, cut corporate taxes and loosen regulation.

Since the Fed’s first rate hike in December 2015 U.S. financials have risen 25 percent, outstripping Wall Street’s 19 percent rise.

By contrast, UK bank stocks have gained 17 percent over the same period, underperforming the broader FTSE 100’s 25 percent rally. Euro zone financials are barely up at all, while the benchmark Stoxx 50 index has risen 25 percent.

But with the “Trump bump” evaporating and inflation remaining stubbornly low, the U.S. yield curve is flattening. The gap between two- and 10-year U.S. yields is now around 80 bps, the smallest gap since September last year.

Flatter yield curves hurt banks, as the gap between the level they borrow at (short end) and lend at (long end) narrows. Another potential worry for U.S. banks in the months ahead.

Editing by Jeremy Gaunt

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