Breakingviews- Yield curve shifts look less lucrative for banks

Tue Sep 10, 2013 2:33pm IST

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(The author is a Reuters Breakingviews columnist. The opinions expressed are her own.)

By Swaha Pattanaik

LONDON, Sept 10 (Reuters Breakingviews) - When longer-term interest rates creep up, that’s usually a cue for banks to rake in bigger profits by borrowing much more cheaply than they lend. Regulation and the economic environment complicate the equation this time.

Banks fund their mainly long-term lending – like mortgages – with short-term borrowings, for instance on the interbank lending market. Recent movements in the sovereign bond market, which is the starting point for what banks charge, should help them. The spread between British two- and 10-year bond yields has nearly doubled since May 1. It has risen by three quarters in the United States and by more than half in Germany.

Central banks’ promises to keep interest rates low are tethering short-term market interest rates. Longer-dated yields are freer to rise as growth picks up and traders anticipate the end of easy money policies. Hence the so-called yield curve, which plots rates as maturities increase, is getting steeper.

However, banks may not be able to benefit as much as in the past. Regulation has changed the rules of the game. National policymakers are keeping a much closer eye on how well banks match up their assets and liabilities. As a result, banks are now less likely to borrow heavily in the short-term wholesale funding market in order to make longer-term loans.

Demand for credit may be the other constraining factor. In the past, core yield curves have typically steepened to these levels because of the strength of economic activity. This time, at least part of the curve steepening is due to central banks’ current unusual policy stance. For example, between 1990 and 2005, the U.S. economy was growing twice as fast, or more, when the spread between two- and 10-year Treasury yields was this wide. Households and firms may not therefore have the same ability to absorb sharp increases in borrowing costs.

Of course, some banks will find current yield curve trends helpful and this is likely to be factored into share prices. But the financial world may have changed too much for investors to bank on these relationships to the extent they did in the past.

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CONTEXT NEWS

- In the United States, the 2/10-year government bond yield spread has widened to 246 basis points from 141 basis points at the beginning of May.

- In Germany, it has risen to 173 basis points from 110 basis points.

- In Britain, it has grown to 243 basis points from 133 basis points.

- Reuters: Low rate pledge buys time but builds risk for fragile banks [ID:nL6N0FI1IN]

(Editing by Chris Hughes and Viktoria Dendrinou)

((swaha.pattanaik@thomsonreuters.com)) Keywords: BREAKINGVIEWS YIELD CURVE/BANKS/

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