Interest rate boon for UK banks coming to an end despite BoE’s 25 basis point hike
Banks have been revelling in the BoE’s sharp rate hikes, but today’s 25 basis point hike – which brings interest rates to 4.5 per cent – is unlikely to improve banks’ bottom line significantly, analysts said.
Increasing competition and regulatory pressure means banks will likely have to pass on more of the rate hike – and any subsequent rate hikes – to consumers.
This means that while 2022 and 2023 have been bumper years for UK banks thanks to rising rates, many analysts argue that the interest rate boon is slowly coming to an end.
S&P Global’s Richard Barnes told City A.M. that today’s “rate hike is a positive for bank earnings but certainly much less of a positive than the rate hikes at the beginning of this tightening phase.”
Barnes explained that in the earliest phases of the hiking cycle, the pass through to consumers was “extremely low”.
Over time, the pass through has increased due to competition between banks and regulatory pressures. Just yesterday a series of banks came under fire from MPs for offering “measly” rates on their savings accounts.
On top of this, the higher rates on offer for other investments have seen customers move more money into higher-yielding products like National Savings & Insurance accounts.
“That’s what you’re seeing now and with the rate hike again today, the pass through is going to be higher than it was previously as well,” Barnes said.
While rising rates have been beneficial for banks, there are also risks as borrowers face ever higher costs potentially tipping more into default.
Investec’s Roger Lee told City PM “the market is very concerned that higher interest rates are going to lead to increasing credit default, that is a logical progression.”
In order to cope with possible higher rates of default, banks have boosted their provisions for bad loans. This has been a drag on profitability.
However, so far banks have seen very low levels of default. Lee argued this was because “the primary driver of credit default is unemployment.”
“You’ll get much higher defaults if you get higher unemployment, but we’re not really seeing a significant rise in unemployment at the moment,” Lee said.
Barnes said although he expects some “normalisation…we’re not expecting anything more severe”.
The collapse of Silicon Valley Bank (SVB) also demonstrated another risk from rising rates: duration risk.
When rates rise, the value of a bank’s bond portfolio decreases. This meant SVB, like many smaller banks in the US, was sitting on huge ‘unrealised losses’ on fixed bonds. These losses were crystallised when depositors pulled their cash and SVB had to sell its bonds to meet withdrawal requests.
This is much less of a concern for UK banks however, with Barnes arguing “unrealised losses on government bonds is not really a material issue for UK banks”.
In the UK, banks have to convert bonds from having a fixed rate to a variable rate, meaning their value fluctuates as rates change. This prevents them from racking up unrealised losses.
“UK banks are very tightly regulated to ensure that there isn’t this duration risk that we’ve seen within the smaller US banks,” Lee argued.