Banks margins shrink in low interest rate environment

Interesting take on the trouble with low yielding savings environments.

Though they pay their depositors zilch, commercial banks’ margins are shrinking while loans stagnate.

Time was that banks used to feast on cheap money. Bank stocks would rally on the hint of Federal Reserve interest-rate reductions since the banks would cut the rates they paid to depositors with greater alacrity than what they charged borrowers, just as big oil companies are apt to lower the prices at the gasoline pump more slowly than crude oil comes down in price.

The Fed has pegged the cost of money virtually at zero—technically a target for the overnight federal funds rate of 0-0.25%—since December 2008 at the depth of the credit crisis. And it looks as if the fed-funds rate won’t be lifted off the floor for a year or so, by the reckoning of the financial-futures market, and may climb to just 0.5% by the time of the Federal Open Market Committee meeting scheduled for Oct. 23-24, 2012.

You’d think the prospect of free money would be just the “juice” that would permit banks to perform like Barry Bonds when he was bashing baseball’s home-run records. But you’d be wrong.

It seems that zero percent money is a drug that loses its potency the longer it’s administered. Even banks may be beginning to feel the same effects as their long-suffering depositors—dwindling income from interest rates so tiny you need a magnifying glass to see.

Citigroup’s bank analysts led by Keith Horowitz slashed estimates for large regional bank companies because continued rock-bottom interest rates will mean markedly lower earnings for 2012 than had been expected. This realization was a contributor to a weak financial sector Tuesday, with the KBW Bank SPDR exchange-traded fund (ticker: KBE), which tracks the Keefe Bruyette & Woods bank-stock index, falling more than 1% in a relatively quiet session.