Are higher interest rates really good for banks?

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A puzzling thing happened following the Reserve Bank Board’s decision last week to raise interest rates faster with a 0.5% hike.

Although it is recognized that rising rates are great for banks because they widen their net interest rate margins and boost their earnings, the stock prices of the big four banks have fallen sharply in response to the rise.

There are a number of explanations as to why this happened, although reading the minds of investors en masse is still a difficult task.

Is a flood of bad debt imminent?

One theory is really grim – that rising rates will lead to lower house prices and a sharp rise in loans that will become bad as heavily indebted borrowers are pushed over the edge by rising repayments.

At this point, that seems unlikely, given the advance on their payments that many home loan borrowers have on their mortgages, although it wouldn’t be a complete surprise if bad debts started to rise.

If there is a high level of mortgage sales amid falling house prices, this could also increase bad debt provisions for banks.

Has the deposit war already started?

Another fear is that the big banks are ill-prepared to wage a sudden war on deposits after the pandemic and the stimulus payments combined with rock-bottom interest rates have seen billions of dollars flowing into the banks at very high interest rates. low or even zero.

Some signs could be changing, with investment bank Macquarie (ASX:MQG) preparing to rapidly increase its retail bank deposits by launching a transaction account that pays 1.5% interest on amounts up to 250,000 $ – a big increase from Macquarie’s previous rate. 0.2%.

Right now the big four banks are offering ridiculously low rates on their transaction accounts and are able to use this huge pot of almost free money that some estimate at $100 billion to take out loans at much higher.

Even if the rates for these loans increase in line with the rise in the RBA, if the large retail banks are forced to start paying more for their deposits, it reduces their margins compared to the current situation.

Macquarie spared the worst of the share price crash

Macquarie’s disruption of the deposit market follows its moves to increase its portfolio of home loans and helps explain why Macquarie was spared the worst of the share price falls the big four have suffered.

Indeed, share price declines over the past week were roughly in line with banks’ filing bases, with Westpac (ASX:WBC) and Commonwealth Bank (ASX:CBA) falling somewhat steeper than ANZ (ASX : ANZ) and National Australia Bank (ASX: NAB).

At the moment Macquarie is a small player in the transactional account space – less than 1% of the market – but offering such a competitive rate on a transactional account could certainly force action from the big four who are currently offering high interest from 0.01% on trading accounts if you are very lucky and meet certain conditions.

For Macquarie, offering a higher deposit rate is akin to a form of advertising, as it can always reduce rates if the product is too successful.

For other banks to compete with this type of rate on transaction accounts is a very big headache because the number of accounts is so much higher and the interest payments would quickly add up to serious money.

Higher term deposit rates are easier for big banks

It is easier for the big banks to simply offer better term deposits rather than higher transaction account interest, which they are starting to do following the rise in the RBA.

On the client side, deposits are much easier to move than loans, so clients can be more mobile with their savings.

The other theory doing the rounds to explain Macquarie’s better performance was simply that it’s much smaller in the home lending space than the big four, so it was less exposed than other banks to any growth in bad loans. .

Whatever the reason for its relative outperformance, Macquarie has launched the first salvo in what could turn into a full-scale war for deposits in the banking system – something that hasn’t really happened during the long decline. official interest rates since 2010.

Money is no longer a trash can

In the process, individual investors will have to quickly adapt to a different environment in which the old “money is trash” mantra may need to be changed.

As for those who hold bank stocks, the idea that higher rates are good for bank profits may be true or things could really turn out differently this time around.

This is a judgment call about an unknowable future, although no matter how high deposit rates go, cash in the bank is unlikely to match the dividend payments made by banks for some time to come.

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