The Bank of England is going to raise interest rates at some point and it might well be Lloyds (LON: LLOY) and NatWest (LON: NWG) who benefit more from this than Barclays (LON: BARC) and HSBC (LON: HSBA). Whether or not the Bank of England announces an interest rate rise today at noon, or sometime later, this is still generally true.
The thing to remember is that banks live off the margin. It’s the difference between the deposit rate they payout and the loan rate they receive in – the gap between the two is the margin – which provides the gross income on traditional banking business.
Yes, obviously, they’re paying out near nothing in interest at present. But they’re also able to charge only a little bit above near nothing as well. Margins, in banking, are compressed by low interest rates in general. So, as and when interest rates rise margins expand. Even if the relationship between the two rates stays the same the actual money number increases as rates rise.
This is compounded by the “float”. The money that flows through current accounts generally isn’t earning interest. And no one has a large stock in a current account either. But add up the flow through them and on average that’s a huge amount at any one time. The banks get to lend this out but don’t have to pay for it. Rising interest rates mean the effect of the float is a leveraged addition to bank profits.
The affects the British banks differently though. Barclays has that substantial investment banking operation. So, Barclays is less leveraged to changes in interest rates than the others. Simply because investment banking profits at Barclays don’t change in the same manner as traditional banking revenues.
HSBC has a substantial overseas business – rather larger than the domestic to the UK one in fact. So, an interest rate change in sterling – which is all any BoE action can change – affects HSBC less. Why would a change in UK interest rates affect HSBC borrowing in HK$ and lending in HK$, after all?
Lloyds and NatWest though, their businesses are largely UK and thus sterling based. Lloyds and NatWest are largely borrowing in sterling to finance loans in sterling. So, any change in the margins that can be charged on sterling money benefit them more than other banks like Barclays and HSBC.
We don’t know whether the Bank of England is going to raise rates today. Inflation at 5.1% by the CPI measure looks high but a lot of that is due to energy prices which aren’t amenable to interest rate changes. But we do generally think that at some point the BoE is going to lift UK interest rates up off the floor. At which point it’s reasonable to expect, on this factor alone, outperformance by Lloyds and NatWest against Barclays and HSBC.
Lloyds and NatWest live, near exclusively, off their sterling lending margins in a way that HSBC and Barclays don’t. So, rising interest rates which expand margins can be expected to benefit the pair of Lloyds and NatWest more than the pair of Barclays and HSBC.
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Tim Worstall is a freelance writer specialising in economics and the financial markets.