Academic journal article ABA Banking Journal

Net Interest Margins and the Yield Curve: Less Effect Than Expected

Academic journal article ABA Banking Journal

Net Interest Margins and the Yield Curve: Less Effect Than Expected

Article excerpt

Most basic asset/liability models predict that as the yield curve flattens, net interest margins compress. That makes some intuitive sense-imagine you are funding a 30-year fixed-rate loan with 5-year CDs; since the CDs will reprice upward and the loan yield is set you will see your margins compress. Of course, this scenario is just one of many. You could conceive of a riskier portfolio constructed of adjustable-rate loans, indexed against the prime rate, funded by low-cost transaction account deposits, that would benefit in a case like this. The loans would reprice upward and since transaction accounts are largely interest free or very low interest, they will generally reprice more slowly or at a much more controlled pace and margins would expand.

Reality in a loan portfolio is somewhere in between those two scenarios, with a bank tapping multiple funding sources and holding a diversified loan portfolio. The expectation is then for there to be some margin compression as the yield curve flattens.

To get a sense for the behavior of the average bank, SNL looked at the average net interest margin for all active major exchange-traded banks over the last five quarters and compared those results with the spread between the 10-year Treasury note and the Fed funds rate as a proxy for the effect of a flattening yield curve.

The chart shows that as the spread between the 10-year Treasury note and the Fed funds rate compressed between the first quarter of 2005 and the first quarter of 2006 the average net interest margin for all major-exchange traded banks remained relatively stable, staying in the 4. …

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