July 29, 2023 / VOLUME NO. 272

This Wasn’t Supposed to Happen

In banking, rising rates are supposed to benefit the industry. But we all know that’s not necessarily the case. 

As interest rates rise, banks can charge more for loans. Meanwhile, banks tend to keep rates low for much of their deposit base, increasing rates slowly and with a bit of a lag compared to loans. That mismatch improves the margin spread, the difference between the cost of funding and the income from loans, boosting profitability. 

But such a scenario has become hard to come by in banking lately. Thanks to the Federal Reserve’s efforts to tame inflation, rates have risen 11 times since March 2022. The Federal Open Market Committee announced this week it would increase the federal funds rate by 25 basis points to a range of 5.25% to 5.5%. 

Public banks have been reporting second quarter earnings recently, and the trend shows continued margin pressure is leaving few banks unscathed. In fact, the industry recently reached a tipping point.

Loan yields, the rates banks charge for loans, and deposit costs, the interest banks pay on deposits, both began to rise in the second quarter of 2022. “Loan yields increased significantly more than deposit costs between second quarter 2022 and fourth quarter 2022,” according to the Federal Deposit Insurance Corp.’s Chairman Martin Gruenberg in a recent speech. “This trend reversed in the first quarter, as the banking industry reported that yields on loans increased by 32 basis points while the cost of deposits increased by 43 basis points.” 

Banks are having to contend with deposit rate competition. To stem the outflow of deposits, they’re paying higher rates to depositors and through wholesale borrowing. Last year, I anticipated some banks would do better than others in a rising rate environment. This year, it’s becoming clear that rising rates are doing a lot of damage to a lot of banks. Bank Director recently released its 2023 Governance Best Practices Survey, sponsored by Barack Ferrazzano’s financial institutions group, which found that almost 93% of respondents think their board is somewhat or very effective at monitoring asset/liability risk. But it’s been 40 years since the industry saw this kind of rising rate environment. I’m hoping that bank directors beef up their skills and knowledge base to provide proper oversight in the months ahead. 

• Naomi Snyder, editor-in-chief of Bank Director

More issues such as these will be covered during Bank Director’s Bank Board Training Forum in Nashville, Sept. 11-12, 2023.

Can Bank Directors Really Govern Risk?

As the failures of Silicon Valley Bank, Signature and First Republic demonstrate, the risk environment can change quickly, and banks must be able to react accordingly. 

“To ask intelligent, successful people who do not understand the banking business reasonably well to oversee risk in a banking institution, I think, is unrealistic.”

— Michael O’Neill, former chairman of Citigroup

• Jack Milligan, editor-at-large for Bank Director

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