Net Interest Margin Question
Why does NIM decrease when interest rates decrease, seems to me it should be the other way around. For example, when the Fed Funds Rate dropped from 2% to 0% wouldn't that cause a much lower deposit rate, and banks would have to pay less money on deposits? While their 6-7% loans were still out there and making them money? What am I not getting
Also aren't deposit rates super-low now? Which is good..
First year fig guy here so may not be 100% right but here’s the general idea
Deposit rates haven’t been materially high in a long time so lowering them isn’t a major needle mover.
On the other hand, loans that are newly originated may have a substantially lower interest rate and existing loans with floating interest rates (aka loans tied to LIBOR etc. which moves daily) will also decrease materially.
Generally loans will see a larger impact from interest rate changes than deposits and thus NIM will decrease with interest declines.
Unrelated question, but do you have any good fig primers that you could recommend, already familiar with the deutsche large cap bank primer from 2011 wondering if you know of any for different verticals - thanks!
del
Unfortunately I don’t have any primers that I’ve seen. Sorry I couldn’t be more help
This is a bit of a tricky question. You are correct there would be little affect if fed funds rate dropped but the spread between deposits (liabilities for banks) and loans (assets for banks) remained the same. But that is never the case, so you are sort of missing the forest for the trees.
Instead, what is relevant is the "flattened yield curve." Basically, if the fed funds rate has dropped that probably means that the entire curve has flattened, signaling a long term decrease in spreads for a bank. A bank basically makes money by "lending long (the asset side) and borrowing short (the deposits side)." Think of a mortgage (lending long) and then deposits (borrowing short). If the yield curve is flat then the spread between lending long and borrowing short is extremely low, harming NIM.
Other comments have addressed the major pieces (deposit rates already being low, floating rate loans, and new originations) but the major thing we are missing here is prepays. Prepays are a major factor affecting margin when rates drop and you have a lot of fixed rate exposure.
In summary, yes, NIM decreases when rates drop, but its a bit more complicated than what you hypothesized :)
that made a lot of sense thank you!
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