Banking sector booms after rising interest rates
By Jenal Mehta
13:03, 24 February 2022
UK banks are reporting rising profits in their latest financial reports, as increases in interest rates bodes well for the sector. With persistent growth in energy prices and current geopolitical tensions in the European region giving rise to inflation, this trend in the banking sector may continue.
After absorbing loses due to low interest rates during the coronavirus pandemic, the financial sector is poised for recovery now that rates have risen. HSBC, Barclays and Lloyds all reported higher profits this week for the fourth quarter of 2021, with expectations of further growth during in the coming year.
UK banks are not directly affected by current geopolitical situation. Economists believe persistent rise in energy prices is likely to keep inflation and interest rates high, which will indirectly benefit banking profits.
Analysts believe this sector is likely to outperform the coming year as rates are due to further increase in the short term.
Promising results
HSBC reported on 22 February that annual profit after tax rose to $14.7bn (£10.8bn) during 2021, an increase of $8.6bn year on year, with its largest growth coming from the UK.
Noel Quinn, HSBC Group Chief Executive comments: “Our net interest income outlook is now significantly more positive. If policy rates were to follow the current implied market consensus, we would expect to deliver a RoTE [return on tangible equity] of at least 10% for 2023, one year ahead of our previous expectations.”
Barclays announced results on 23 February, reporting annual profit after tax of £7.2bn during 2021, almost triple the level reported during 2020.
On 24 February, Lloyds reported a growth in net profits of 9% year on year to £15.8bn during 2021. It also reported a 4% rise in interest income, mostly coming from interest-earning banking assets.
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Inflation and Interest rates effects on the banking sector
Long term Inflation is not particularly good news for the financial sector. A report by Schroders outlines that: “Financials, perform comparatively better, as their cash flows tend to be concentrated in the shorter term. But high inflation can still be harmful, especially for banks, because it erodes the present value of existing loans that will be paid back in the future.”
That being said, the subsequent rise in interest rates to combat inflation can be of benefit to the sector. Chris Davis, Chairman of David Advisors states in a recent report: “As investors fret about the possibility of higher interest rates, many financial companies stand to benefit, as higher interest rates increase earnings.”
He adds that for banks higher interest rates means increase in spreads between deposits and loans.
Barclays said in its annual report: “Interest rate rises could positively impact the Group’s profitability as retail and corporate business income increases due to margin decompression. However, further increases in interest rates, if larger or more frequent than expected, could lead to generally weaker than expected growth, reduced business confidence and higher unemployment.”
Per Angel Talavera, head of Europe economics at Oxford Economics, the persistence of inflation will be unlikely in the long term, thus continued interest rate spikes are also not likely to occur: “Longer term, we think the structural disinflationary factors present before the pandemic will eventually reassert themselves, making a permanent shift of inflation regime unlikely. As a result, we don’t expect the ECB [European Central Bank] to embark on a sustained interest rate hike cycle.”
Rates are expected to rise
Analysts at ING believe that lending rates are on the last moments of decline before they begin their incline for 2022.
The eurozone bank lending rate dropped in December, lower than in previous month. The reason behind this was, as the report states: “December was the benchmark month for banks to reach a certain volume of lending to businesses (and non-mortgage lending to households), and some banks apparently needed a final sprint to make sure they’d reach their benchmark.”
This year will see rates rise, ING states: “Both eurozone-wide monetary policy and national macroprudential policies are likely to put increasing upward pressure on bank rates, for mortgages in particular.”
Geopolitics
The economic impact of the current political tension in eastern Europe is likely to only effect the rest of Europe via the rising costs of energy. Oxford Economic’s Talavera outlines in a report that sectors highly dependent on energy, ones who directly trade or have financial links with Russia will be most impacted.
Regarding the banking sector specifically, Talavera states: “For most European countries trade links are relatively minor, so with a few exceptions present only a low threat to the outlook. Similarly, financial links are also limited, with only three European banks having a noteworthy presence in Russia and will not represent a systemic risk to the banking system.”
Banking sector likely to outperform in 2022
Portfolio managers at Hennessy Funds have a positive outlook for the financial sector. They state that stock values of banks were severely impacted by low interest rates and asset quality issues during 2020. Since then the banks have seen a dramatic turnaround, in 2021 large banks saw a 77% stock price growth.
For the near future they believe: “As the economy continues to recover, interest rates should continue to rise and loan demand should increase, allowing companies to significantly grow their portfolios and net income.”
David Kastner CFA, Senior Investment Strategist at Charles Schwab also shares a similar outlook for the sector “the sector has strong underpinnings, and if interest rates continue to rise—as we expect—from a three- to six-month tactical perspective, we think outperformance of the sector is more likely.”
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