The biggest U.S. banks are still counting on Fed Chairman Jerome Powell not to heed those calls. In their latest quarterly filings, the scenarios that look at the potential impact of interest-rate changes on income all assumed a zero floor in the U.S. while considering lower rates worldwide.
Nevertheless, the banks are running internal models with negative rates, executives say. While they won’t reveal the numbers, executives acknowledge that the drop in income would grow incrementally as rates went further and further below zero. European lenders’ interest margins have declined by more than a quarter since the European Central Bank went negative, starting with -0.1% in 2014 and ending last year at -0.5%. Margins in Japan have dropped by about the same since 2016 after the Bank of Japan went to -0.1% and stayed there.
Algebris’ Gallo says U.S. banks have more pricing power in lending than their European counterparts because the banking system is dominated by a few large companies, which should cushion some of the blow from negative rates, at least initially. Most loan contracts in the U.S. have zero-rate floors even if they’re pegged to market interest rates, executives say. The largest U.S. lenders also earn quite a lot more than European peers from capital-markets businesses after having gained share in recent years.
Despite all the push-back, the Fed might move rates below zero if the right conditions unfold, according to JPMorgan analyst Nikolaos Panigirtzoglou. Those include the market ramping up its wagers again for negative rates and other leading central banks that haven’t gone negative yet switching tracks to do so, Panigirtzoglou said. In the short run, that would be a good move, though the benefits would erode after a year or two, he said.
“Negative Fed policy rates should help liquidity in the banking system as reserves should start propagating rather than staying idle at the big banks, which have been hoarding them,” said Panigirtzoglou, a London-based global market strategist. “For some smaller banks there are shortages of reserves and they’ve had to pay higher rates in the interbank market to get liquidity.”
While the Fed hasn’t yet delved into the sub-zero policy-rate zone, Treasury yields of the shortest of maturities have traded negative before and currently those with tenors out to two years have rates below the 0.25% top of the central bank’s target range. Two-year notes yield about 0.17% and four-week Treasury bills are at just 6 basis points. From mid-March to early April the four-week bill rate was mostly negative, in part due to shortages of the security.
“Market rates are so close to zero, negative rates are no longer a far-fetched scenario for U.S. banks,” said Brian Kleinhanzl, an analyst with Keefe, Bruyette & Woods based in New York. “The longer they last, negative rates are a slow burn on net interest margins. Coupled with bad credit, that would permanently impair their business models just like it did European peers.”
Several years of negative rates would probably bring market valuations of U.S. banks to levels European and Japanese rivals have faced for a while, Kleinhanzl said.
This article was provided by Bloomberg News.