I've read this claim many times in the news: banks are making less profit from the lending business when interest rates are historically low.

Isn't this a bogus claim? Let me clarify: To loan money out, the bank either needs to accept deposits from its clients, or borrow money from the central bank. Both of these operations are costly for the bank (they have to pay the deposit rate to the clients, or pay the central bank's rate for loaning funds from them). Thus, the profit from the bank's lending business is the difference between the interest rate charged from the borrowing client and the interest rate that the bank has to pay for the funds. Hence, profit has nothing to do with the level of interest rates. Is this correct?

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    How does this relate to personal finance? Commented Jan 26, 2017 at 20:37
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    I have invested in a couple bank stocks, and if the banks are making less money in this interest rate environment, it could affect my investments as well.
    – lopta88
    Commented Jan 26, 2017 at 20:41
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    You should consider index funds. There's more regulatory risk to banks than interest rate risk. Commented Jan 26, 2017 at 20:45
  • @NathanL: That may be true today. But during the 1970s, interest rate risk was the greater danger.
    – Tom Au
    Commented Jan 27, 2017 at 9:10
  • In a free-trade environment, you're mostly correct (that is, the equilibrium is the same, but it might take time to reach that equilibrium). However, banks are regulated quite a bit - forced to deal in a certain currency, borrowing from a central bank etc. These things can have important impact on the profitability - say, if you have a forced lower limit on deposit interest and an upper limit on lending interest.
    – Luaan
    Commented Jan 27, 2017 at 12:00

3 Answers 3


profit has nothing to do with the level of interest rates. Is this correct?

In theory, yes. The difference that you're getting at is called net interest margin. As long as this stays constant, so does the bank's profit. According to this article:

As long as the interest rate charged on loans doesn't decline faster than the interest rate received on deposit accounts, banks can continue to operate normally or even reduce their bad loan exposure by offering lower lending rates to already-proven borrowers.

So banks may be able to acquire the same net interest margin with lower risk. However the article also mentions new research from a federal agency:

Their findings show that net interest margins (NIMs) get worse during low-rate environments, defined as any time when a country's three-month sovereign bond yield is less than 1.25%.

So in theory banks should remain profitable when interest rates are low, but this may not actually be the case.

  • I think this somewhat depends on the "bank" (not really the right word) and how they diversify their business.
    – maplemale
    Commented Jan 26, 2017 at 21:02
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    Consider also the reason for the low interest rates -- if rates are low because a central bank is trying to counteract a general lack of enthusiasm in the economy for borrowing money, then it's fairly easy to speculate that the low interest rates and the banks low profits might have a common cause :-) Commented Jan 27, 2017 at 12:21
  • @SteveJessop, an excellent example of "correlation not causation"!
    – Nosrac
    Commented Jan 27, 2017 at 13:58

I've read this claim many times in the news: banks are making less profit from the lending business when interest rates are historically low.

The issue with most loans is they can be satisfied at any time. When you have falling interest rates it means most of the banks loans are refinanced from nice high rates to current market low interest rates which can significantly reduce the expected return on past loans. The bank gets the money back when it wants it the least because it can only re-lend the money at the current market (lower) interest rates. When interest rates are increasing refinance and early repayment activity reduces significantly.

It's important to look at the loan from the point of view of the bank, a bank must first issue out the entire principal amount. On a 60 month loan the lender has not received payments sufficient to satisfy the principal until around 50th or 55th month depending on the interest rate. If the bank receives payment of the outstanding amount on month 30 the expected return on that loan is reduced significantly.

Consider a $10,000, 60 month loan at 5% apr. The bank is expected to receive $11,322 in total for interest income of $1,322. If the loan is repaid on month 30, the total interest is about $972. That's a 26% reduction of expected interest income, and the money received can only be re-lent for yet a lower interest rate.

Add to this the tricky accounting of holding a loan, which is really a discounted bond, which is an asset, on the books and profitability of lending while interest rates are falling gets really funky.

And this doesn't even examine default risk/cost.

  • This comments on bank profitability in an environment of reducing rates, not one of low rates.
    – jwg
    Commented Jan 27, 2017 at 11:44
  • @jwg, true. Low is a relative measurement. Interest rates move over time and you can only get to a "low" interest rate environment if you were in an "high(er)" interest rate environment. Right now the 30 year mortgages that were written in 1987 are just starting to complete; but, I'd wager almost all have been refinanced or the property transacted at least once since then. Strictly examining the profitability of banks in an X% environment would involve the specific bank expenses and scale of its lending business not the delta between the fed rate and the market rate.
    – quid
    Commented Jan 27, 2017 at 17:52

Banks make less profit when "long" rates are low compared to "short" rates.

Banks lend for long term purposes like five year business loans or 30 year mortgages. They get their funds from (mostly) "short term" deposits, which can be emptied in days.

Banks make money on the difference between 5 and 30 year rates, and short term rates. It is the difference, and not the absolute level of rates, that determines their profitability. A bank that pays 1% on CDs, and lends at 3% will make money. During the 1970s, short rates kept rising,and banks were stuck with 30 year loans at 7% from the early part of the decade, when short rates rose to double digits around 1980, and they lost money.

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