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Fed Cut Rates to 0% on Coronavirus Woes: Banks Worth Buying?

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In an accelerated move, the Federal Reserve slashed interest rates to zero (for the first time since the 2008 financial crisis) to provide additional support to the U.S economy for combating coronavirus-related slowdown. This was preceded by an emergency rate cut of 50 basis points by the central bank earlier this month.

The Fed stated, “The effects of the coronavirus will weigh on economic activity in the near term and pose risks to the economic outlook.”

The scheduled meeting of Fed officials on Mar 17-18 now stands cancelled. The next scheduled FOMC meeting will take place on Apr 28-29.  

Further, the Fed statement noted, “The Committee expects to maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.” Thus, there is less chance of the central bank considering negative rates.

Additionally, the central bank announced the resumption of the ‘quantitative easing’ policy of purchasing at least $700 billion worth of Treasury bonds and mortgage-backed securities over the next few months. There are no monthly or weekly limits on these purchases. Also, the Fed lowered reserve requirements, and will allow the financial firms to tap into its capital and liquidity buffers to encourage lending activities across the country.

Several major banks including JPMorgan (JPM - Free Report) , Bank of America (BAC - Free Report) , Goldman Sachs (GS - Free Report) , Citigroup (C - Free Report) and Morgan Stanley (MS - Free Report) on their part have suspended share repurchases through second-quarter 2020. The banks intend to utilize the capital to lend to individuals and businesses adversely impacted by the coronavirus outbreak. (Read more: Big US Banks Suspend Stock Buybacks Amid Coronavirus Pandemic)

All these measures taken to stabilize the markets seem to have again spooked investors. All three indexes — S&P 500, Dow Jones and Nasdaq — plunged and triggered circuit breakers.

How Will the Zero Rates Impact Banks?

For banks, one of the biggest beneficiaries of rising interest rates, this is definitely bad news. Banks earn net interest income by charging borrowers higher long-term interest rates, while doling out smaller interest rates to depositors. This results in improvement in net interest margin (NIM). However, growth in banks’ net interest income is expected to get hampered owing to zero rates. This will also result in decline in NIM.

We all know that banks’ financial performance is largely dependent on the nation’s economic health. Thus, this second unexpected rate cut indicates that the U.S. economy is already slowing down and will have an adverse impact on banks’ financials.

This is also likely to result in lower demand for loans, owing to reduced business activities. Also, it could lead to a rise in delinquency rates. Thus, banks’ asset quality is expected to deteriorate.

Should Investors Stay Away From Banks?

This is not 2008, when the banks had collapsed, resulting in a financial crisis.

Over the past decade, several operating efficiency strengthening measures, which along with stringent regulatory capital requirements, have made banks fundamentally stronger. Banks have moved away from risky operations and are now focused on strengthening core businesses.

Also, a conservative lending policy, higher interest rates and improving economy supported the banks’ performance. Last year was one of the strongest growth years for banks since the financial crisis, despite the Fed cutting rates thrice to support the economy during the U.S.-China trade war.

Global diversification and changing mix to focus more on other revenue sources, along with technological upgrades to ward off competition from Fintechs are expected to continue supporting banks’ profitability. Also, there has been a rise in consolidation efforts among the industry players, following the easing of some of the stringent rules and lowering of corporate taxes.

No doubt, near zero rates are here to stay at least for the next couple of quarters. But one can bet on banking stocks that are fundamentally strong and have long-term prospects. However, at the same time, keep your eyes open to near-term matters.

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