How can fluctuations in market interest rates influence bank profits?

Question

How can fluctuations in market interest rates influence bank profits?

Answer

It is usually believed that the banking sector makes substantial profits from high loan rates, but the majority of bank regulators demonstrate their opinion that rising market rates are not necessarily associated with significant profits. In cases when interest rates increase, as a result of specific policy actions or other factors, bank managers recognise changes in the asset and liability aspects of their institutions’ balance sheets (Bannigidadmath and Narayan, 2016). The way in which market interest rates influence bank revenues is represented by a situation where increased market rates raise the precise amount of income bank can earn on new assets. Moreover, it has been argued that bank revenues tend to adjust to new market conditions, which illustrates the interrelations between fluctuating market interest rates and bank profits (Dia and Menna, 2016). Market interest rates also influence bank profits through their impact on important bank decisions, especially in relation to the specific loans and securities that can be purchased over time. It is important to note that fluctuations in market interest rates can have a negative impact on bank profitability only in case asset and liability returns adjust at substantially different speeds. Banks and financial institutions with different sizes obviously respond differently to market rate changes. The revenues and costs available at larger banks imply that they tend to adjust more quickly to the changing environment in terms of market interest rates (Bannigidadmath and Narayan, 2016). Thus, larger banks are believed to handle interest-sensitive customers more efficiently compared to smaller banks. Yet, the performance of each individual bank is important in determining the exact adjustments of revenues and costs, which in turn affect bank profitability. It has been indicated that asset returns respond more efficiently to market interest rates changes compared to liability costs (Drakos et al., 2016).

References

Bannigidadmath, D. Narayan, P. K. (2016). Stock return predictability and determinants of predictability and profits. Emerging Markets Review. 26(1) 153-173. Dia, E. Menna, L. (2016). Productivity shocks, capital intensities, and bank interest rates. Journal of Macroeconomics. 48(1) 155-171. Drakos, A. A. Kouretas, G. P. Tsoumas, C. (2016). Ownership, interest rates and bank risk-taking in Central and Eastern European countries. International Review of Financial Analysis. 45(1) 308-319.