A Rising Interest Rate Scenario That Might Be Good for Banks

percent sign buttonA rising interest rate environment is supposed to bad for banks. It turns out that not all rising rate environments are created equal, and rising rates of the past may not be the same today, in a post-QE world. A report from Fitch Ratings on Thursday outlines how a gradual rise in interest rates would be a net positive for U.S. banks.

Again, this is one scenario of rising rates. It is widely assumed that rapidly rising rates, which is not Fitch's scenario, would not be viewed as a positive for the banking sector.

Fitch's view is that a gradual rise in interest rates could translate into improved earnings through improved loan growth and higher pricing. Fitch's base case scenario assumes the completion of the Federal Reserve's tapering program (which is now the case), strengthening world economic growth from 2014 to 2016 and a gradual tightening of monetary policy over the next 12 months. In this scenario, earnings improvement resulting from higher interest rates would be partially offset by higher funding costs and some increased provisioning that comes from higher utilizations and ongoing seasoning of loan portfolios.

Fitch's stress case scenario involves a sharper hike of interest rates amid weakening or stagnant economic growth. This less-likely scenario could be more challenging for U.S. banks, due to higher funding costs without a meaningful pick-up in asset yields. Fitch went on to say that this would "also cause potential shocks to capital via changes in the valuations of bank securities portfolios and possible deterioration of asset quality metrics to the extent that a combination of higher rates and a weaker economy causes credit deterioration in underlying borrowers."

There is one thing to consider about the current assets held by banks. Under both rising rate scenarios, rising interest rates will cause a decline in the value of securities holdings for banks under the Basel III advanced approach.

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