British banking shares – Barclays PLC (LON: BARC), Lloyds Banking Group PLC (LON: LLOY) and Metro Bank PLC (LON: MTRO) among them – are up 15 to 20% over the past month. This is a rather larger rise than the general market so what is it that’s going on?
The basic truth is that banks benefit from higher interest rate environments. While it might not be true – as Modern Monetary Theory insists it isn’t – that banks lend out deposits the end accounting result is as if they do. They must fund their loans from deposits. So, the gross income to a bank is the margin, the difference in the rate it offers depositors and that it charges to borrowers.
As interest rates rise those margins widen. This is even more so as rates come up off the bottom as at present. Depositors tend not to accept negative interest rates so that puts a floor under how little can be paid out. It’s also true that the float – the amount in current accounts – rarely does pay interest so rising rates add to margins there.
OK, good, so as sterling interest rates rise then bank margins will widen. This is obviously known to the wider market as we are seeing those 15 to 20% rises in the Barclays, Metro and Lloyds share prices as interest rates do rise.
We can also see this by looking in an entirely different direction. By looking at the complaints that banks are raising those loan rates but not the deposit ones. As The Telegraph says: “Savers suffer as banks pocket the profit from higher interest rates. Many major lenders have already increased mortgage rates, but none have passed on the benefits of the base rate rise to their customers”. Well, yes, that’s exactly what is going on.
Now, we might think this is all terribly unfair and all that but as investors, as traders, we’ve got to deal with the world as it is in front of us. The amount that banks can charge to borrowers is rising as interest rates in general rise. The amount that banks have to pay depositors in order to keep the deposits isn’t rising. It will, of course, but it will – as it almost always has done in the past – rise more slowly than those lending rates.
This means that margins at the big banks, like Barclays and Lloyds, the smaller insurgents like Metro, will rise. Clearly, if margins rise without costs rising then those increased margins feed straight through to the profit line.
Rising interest rates makes British banking more profitable. Thus the rise in the share prices of British banks like Barclays, Lloyds and Metro. How long this will continue, well, how high are interest rates going to go? That’s what will determine trading positions, views on what the Bank of England is going to do.
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Tim Worstall is a freelance writer specialising in economics and the financial markets.