It finally happened. On Wednesday, the Federal Reserve ruled to increase interest rates by 0.25%. However, this is not the big Christmas gift that most bankers wished for. Although there is pent up demand for an interest rate hike, new competition and the new state of the market after nearly a decade of flat or declining interest rates have changed the playing field.
Ongoing low rates have put a crimp in interest margins. Investors have been putting money into financial stocks in anticipation of the Fed’s decision, hoping that higher interest rates will translate into bigger lender margins. The expectation is that banks and credit unions will be able to pay more for loans and pay little for deposits, but the competition is fierce and banks and credit unions also have new competitors.
Smaller banks are concerned that the slow rate of increase for interest rates will actually lead to further margin compression. At a December 9 roundtable sponsored by the American Bankers Association, attendees were comparing notes on the increase in competition and its impact on loan pricing. As Charles Umberger, CEO of Old Town Bank in Waynesville, N.C., noted:
“The challenge I see with the Fed's moves is that they are going to do enough to further compress the margin yet not enough to materially move our asset yields. It is going to make our margins worse than they are right now. It is going to hit smaller community banks because we're totally spread dependent.”
Banks and credit unions are also feeling new pressure from online banks. Internet banks are taking advantage of the fact they have lower overhead to offer better returns on deposits. The rates for many Internet financial institutions are already more competitive than brick-and-mortar banks, however, depositors are reluctant to move their money. As one banker at the ABA conference noted, “there is real value in having a safe, convenient, nationwide checking system.”
It’s clearly going to take some time for deposit rates to recover, and those who will compete successfully will have to remain alert and nimble. They are going to have to be responsive to customers’ expectations of an increase in deposit returns without dragging their feet. They are going to have to continue to diversify products and strategies, including fees, to keep revenue coming in. The bankers at the ABA conference noted that they are seeing growth in such sectors as commercial lending, commercial real estate, manufacturing, consolidating medical practices and professional services, and other areas. Bankers are going to have to be opportunistic and take advantage of new revenue opportunities while waiting to see when, or even if, interest rates rebound to healthy levels.
However, we all have reason to be cautiously optimistic. For the first time in eight years, the Federal Reserve raised fed funds rates by 25 basis points. Whether your FI is looking to maximize NIM (using MyRI with live deposit and loans rate surveys) or NII (using FeeBuilder with live retail fee data feed), we are here to help you with precision pricing as we begin the dawn of a new interest rate cycle.