Mistakes / Finance for Dummies: No, banks don’t necessarily get more out of loans when rates go up!

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Don’t worry about them, banks make money, low or high … The only big risk is non-repayment of loans.

Do you need to be a banker to know this?

Apparently, no journalist or financially influential agent has ever been a banker in a previous life … The job of a retail bank is to sell money to individuals and businesses, this is called credit. The bank’s margin on loans is determined not only by the difference between the rate at which it receives the money it borrows and the rate at which it sells the money. The bank’s profit is based on the principle that for the same euro the bank will lend it up to 13 times. The margin on the difference between the applied rates does not change much, regardless of whether the rates are low or high. Therefore, the volume of loans is more important for banks than the difference between buying and selling money.

Historically low rates, but … The detail should have shocked you

If you still think that banks’ profits increase significantly with rising interest rates, you have to ask yourself, how did banks manage to publish all these billions of euros in profits (see the bank’s performance and profits) during those years with interest rates below 1%? Everyone knows that the commission of business implementers is about 1% of the amount of borrowed capital, is not it surprising? Well, no, not at all.

In these periods of extremely low rates that we have experienced in recent years, retail banks have never received so much income from loans. How then to explain this living idea that banks will make more profits in times of high interest rates? There have been periods of very high interest rates in the past, but banks have never made as much profit as they did during this period of low interest rates. In fact, the higher the interest rates, the less banks sell loansSimply put, as the risk of default increases exponentially, fewer borrowers fill all the fields for the loan. And as a result of the reduction in loans, banks earn less money because their money sales weaken.

Profit not directly related to changes in interest rates

Any experienced banker can confirm this. Changes in interest rates are not the main criterion for fluctuations in bank profits. The volume of loans is more important. And despite the fact that the financial media regularly reports, raising interest rates for banks is bad news. If their margin can increase without customer complaints, the amount of credit will decrease. Paradoxically, in the stock market, the price of bank securities rises when market interest rates rise. The Pauline reflex, the same as in times of fear, makes gold a safe haven for investment. It doesn’t make any rational sense, but it’s market habits.

Return to the real financial world

With the financial world going upside down, with negative rates, it’s over! This accelerating effect for bank securities is not due to the income from loans during interest rate hikes, but to the fact that banks suffer less from restrictions on guarantee deposits with the ECB. This is the value of financial assets that provide a level of guarantee (AAA), which will now be less expensive. Credit lines from the French state at negative rates have expired for several weeks. The ECB recently confirmed its schedule for raising the key rate, the break is over. Return to the financial world right side up.

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