Banking’s Profitable Decade: Interest Rate’s Role

McKinsey recently reported that banks are seeing their biggest profits in ten years. This boom in profits, they claim, is largely thanks to the increase in interest rates. This increase enabled banks to earn more from loans and mortgages, bumping up the global banking profits by about $280 billion.

To break it down: In the US, there was a significant 500-basis-point jump in interest rates. This change meant banks could improve their net interest margins, leading to the banking sector’s profits rising to $280 billion in 2022. This improvement also increased the return on equity (ROE) to 12% in 2022 and it’s expected to reach 13% in 2023. To give a comparison, the average ROE since 2010 has been only 9%.

Looking at the numbers, McKinsey pointed out that the banking sector’s net earnings surged from $1 trillion in 2021 to $1.3 trillion in 2022, and they anticipate it’ll reach $1.4 trillion in 2023. Interestingly, this comes at a time when some of the major US banks, including JPMorgan Chase, Wells Fargo, and Citigroup, saw an outflow of deposits. Specifically, these banks lost $84.5 billion in deposits in the third quarter of this year alone. Bank of America, Morgan Stanley, and BNY Mellon weren’t spared either, with them losing $44.35 billion.

But what does the future hold for banks? According to McKinsey, four major global trends will shape the path forward:

1. Macroeconomic Shifts: The global economic landscape is changing, with rising interest rates and inflation rates in many regions. There’s also potential for China’s economic growth to slow down. We might be entering a new macroeconomic era with a broad range of potential outcomes.
2. Technological Advancements: Technology is rapidly progressing, and customers expect more tech-driven services. The rise of generative AI, for instance, might change the game, potentially boosting productivity by 3 to 5% and cutting operational costs by $200 billion to $300 billion.
3. Regulatory Changes: As the financial system faces stresses and as new technologies and players emerge, governments are paying closer attention to non-traditional financial entities. For instance, the proposed final phase of Basel III might mean higher capital requirements for many banks.
4. Geopolitical Concerns: The nature of systemic risk is evolving. With geopolitical tensions on the rise, we can expect more volatility and potential restrictions on global trade and investment.

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