28 Mar COTW: Extreme Interest Rate Spreads
- The spread between interest paid on a bank’s liabilities (e.g. deposits) and the interest received on assets (e.g. investments), known as the Net Interest Margin (NIM), is a key driver of bank profitability. Banks generally benefit from higher interest rate environments as they are able to delay raising interest on deposits, while benefitting from higher interest income from investments. This has been the case in the current hiking cycle, as the average U.S. money market bank account yields just 0.48%, while the Fed Funds rate is at 5.0%. This is the largest spread in at least 20 years.
- On the one hand, while banks have benefitted from these recent extreme spreads in interest rates, it has, on the other hand, contributed to the current instability in the U.S. banking system. Depositors have accelerated the movement of money out of bank accounts in favor of U.S. Treasury Money Market funds. Since the beginning of March, $250 billion has moved into U.S. Treasury Money Market funds. Excluding 2020, this is the largest monthly inflow since 2008.
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