At its core, a bank borrows money from depositors and lends it out at a higher rate. The difference, called net interest margin, is the engine of its profits — and it is highly sensitive to what central banks do.
The margin at the centre
When rates rise, banks can usually raise loan rates faster than they raise what they pay on deposits, widening the margin. When rates fall, the reverse can happen.
Why it is not that simple
Higher rates can also reduce demand for loans and increase defaults. Banks holding long-dated bonds bought when rates were low can see their value fall as rates rise.
What to watch
Deposit costs, loan growth and credit quality tell you more about a bank’s health than the headline rate. A bank whose depositors are quick to move money elsewhere has less room to manoeuvre.
Key takeaways
- The margin at the centre
- Why it is not that simple
- What to watch
