The coronavirus pandemic has battered the global economy. Markets are highly volatile and have closed at record lows on multiple days. As investors’ sentiment remains subdued with fatalities climbing worldwide, stocks have been witnessing a roller-coaster ride due to the fear infused massive sell-off.
Meanwhile, both government and central banks are taking measures to boost the economy. The Federal Reserve has made two emergency rate cuts this month, bringing interest rates to near zero (0-0.25%), slashing rates by 1.5%.
Along with that, the Fed announced a “full range of tools” for quantitative easing, in the form of at least $700 billion worth asset purchases that include a $500 billion increase in its holdings of treasuries and a $200 billion increase in its mortgage-backed security portfolio.
Though Fed’s monetary stimulus may provide support to individuals and businesses, the banking business may take a hit in the long run.
Why Near-Zero Rates Will Impact Banks?
Banks are in trouble due to Fed’s rate cut as lower rates impact the profitability of banks. Banks borrow money at short-term interest rates and provide loans at a long-term rate, with a higher difference leading to profitability. Lower rates will result in decline in net income margin.
Another factor that dampens banks’ profitability is high purchase of long-term yielding treasury bonds. Coronavirus-induced fear has increased investments in safe assets like long-term bonds, which resulted in a decline in yields and impacted banks.
Owing to the current health scare, business activities have declined significantly. Chances of a rebound are slim until disruptions from coronavirus abate. Even if businesses take loan to restart work, there are high possibilities that they may become defaulters leading to deterioration of banks’ asset quality.
In spite of chances of low or no profitability, several banking giants have opted for “the Federal Reserve’s discount window facility” as they have substantial liquidity and multiple sources of funding. Among these are Wells Fargo & Company (
WFC - Free Report) , The Goldman Sachs Group, Inc. ( GS - Free Report) , Morgan Stanley ( MS - Free Report) and many more. On Mar 15, banks announced that they would suspend stock buybacks through the second quarter of 2020. Coronavirus Pandemic Making Things Worse?
The coronavirus outbreak has led to store and factory closures along with lockdowns of cities and workplaces. Several firms are drawing down their lines of credit to cover costs and pay employees. This in turn pushes banks to pay out large sum of money within a very short period of time. They also face loss of profitability due to low interest rates.
With interest rates nearly zero, some companies are borrowing money as a precautionary measure and not because they are facing liquidity constraints. The virus has impacted the majority of the industries, from manufacturers, hotel operators, airlines to retailers. These companies have either fully or partially drawn on their revolving credit lines from banks or intend to do so as the pandemic worsens.
On Mar 13, chipmaker Micron Technology, Inc. (
MU - Free Report) said that the company will use the entire $2.5 billion of its revolving credit facility to increase cash holdings, which will give the company more financial flexibility.
Airlines giant United Airlines Holdings, Inc. (
UAL - Free Report) , which has been heavily impacted by the outbreak, has taken out a new secured loan to help combat lower revenues. The Boeing Company ( BA - Free Report) is reportedly drawing on its existing lines of credit.
Banks have to be prepared for deferred payments from small businesses and individuals as they may be late on mortgage or credit card payments. Additionally, declining long-term yield and interest rates in the past few weeks are damaging banks’ profitability from traditional banking and lending activities.
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