Is rising interest rates always good for bank stocks?
If interest rates rise, banks will make money. So, I should just buy bank stocks.
When you hear or read something like that in the news, you naturally want to buy them. I sometimes get excited myself, thinking, ‘This might be a chance!’, so I completely understand that feeling.
It is true that rising interest rates can be a tailwind for banks. However, when it comes to whether all banks will move in the same direction when the wind changes, it is actually a bit more complicated.
Banks are shops that ‘source and lend money’
Let’s compare a bank’s business to a local rental shop.
They take money from depositors and lend it to people buying homes or companies looking to expand their business. The difference between the interest received from borrowers and the interest paid to depositors is one of the pillars supporting a bank’s earnings.
This difference is called the ‘interest margin’.
If lending rates rise while deposit rates rise slowly, the margin the bank receives tends to widen. Looking only at this, you can see why it feels like good news for banks.
However, lending rates and deposit rates do not all move at the same time and by the same amount.
Money lent out for a long time at a fixed rate cannot be changed to a higher rate immediately. Conversely, if a bank raises deposit rates quickly to attract depositors, the costs the bank pays may increase first.
Even with the same news about rising interest rates, how much the interest margin widens varies greatly depending on what kind of deposits a bank collects and under what conditions it lends.
The price of bonds bought in the past may also fall
Also, banks use a portion of the money they hold to invest in ‘bonds’ such as government bonds.
This is where things get a little tricky.
For example, suppose you hold an old bond that only pays a small amount of interest, and a new bond that pays a higher interest rate is introduced.
If the prices were the same, buyers would want to choose the new one. Therefore, to sell the old bond before it matures, you have to lower the price, or it will be difficult to find a buyer.
In other words, ‘rising interest rates’ means that the price of bonds held by banks may fall, leading to valuation losses or realized losses.
Of course, the impact varies depending on whether they plan to hold them until maturity, whether there is a possibility of selling them early, and how long the duration of the bonds they hold is. Since the timing and form in which these appear in financial statements are not the same, you cannot determine the depth of a bank’s wounds just from a single news headline saying ‘a loss was incurred on bonds’.
The possibility that borrowers may struggle
And one thing we must not forget is that rising interest rates lead to an increased repayment burden for those who are borrowing money.
For households paying off a mortgage, monthly budgeting might become tighter. For companies, increased interest payments might force them to reduce spending on new equipment or personnel.
If the burden becomes too heavy, the number of people wanting to borrow new money may decrease, or repayment itself may become difficult.
For banks, lending may stop growing, or costs to prepare for bad loans may increase. While there is a bright side in that ‘interest received increases,’ it is also important to look at the risk side, where ‘the financial health of borrowers may decline.’
Check where the benefits of interest rates appear in financial results
When actually looking at a bank’s financial results, you don’t need to try to read every single detailed item from the start.
First, check if ‘net interest income,’ which is generated from the difference between interest earned from loans and interest paid on deposits, has increased. Next, try to confirm if the loan balance itself is growing and if ‘credit costs’—the provisions for loans where repayment is a concern—have not increased.
Furthermore, take a look at the valuation gains/losses and realized gains/losses on securities. Even if core earnings improve due to rising interest rates, bond losses or increases in personnel and system expenses might be dragging down profits.
Do not judge based on a single number; instead, line up the four boxes of ‘net interest income,’ ‘loan volume,’ ‘credit costs,’ and ‘bond gains/losses.’ This makes it easier to organize how news of rising interest rates has affected that bank.
When comparing with the previous quarter or the previous year, reading the ‘reasons for increase/decrease’ provided in the bank’s financial presentation materials along with the amounts makes it easier to separate temporary factors from interest rate effects.
Don’t lump all ‘bank stocks’ together; take it slow
When comparing banks, in addition to the news that interest rates have risen, try to look little by little at the balance of deposits and loans, the amount and duration of bonds held, the industries of the borrowers, and the ratio of overseas business.
There are banks that can easily translate rising interest rates into earnings, and others where bond losses or the deterioration of borrowers can easily become a burden. The impact received changes just based on whether it is a major bank or a regional one.
Instead of drawing a straight line connecting ‘rising interest rates = bank stocks should rise,’ try thinking separately about where that bank is increasing profits and where burdens are likely to emerge.
Just being able to do this will significantly change how you see the news. You don’t need to try to track every number perfectly from the start. Let’s proceed slowly at your own pace.
The strength of the tailwind and the weight of the baggage at your feet. Why not start by looking at those two things together?
Next time, I will talk about the question ‘Why does the stock price fall even after good financial results?’ in an easy-to-understand way, while organizing perspectives such as market expectations, company earnings forecasts, and ‘selling on the news.’ Please look forward to it!