The chaos in the bond market has been a boon for investment bankers over the past few months. For more than a decade, traders are enjoying their highest levels of income. But the rise of bond-warning people - in theory, investors who spend money on government finances are also helping the affluent world of retail banks.
In theory, lenders should have a decline in profitability. Products such as mortgages are usually associated with central bank interest rates, which fall in the euro zone and the UK. KBW estimates that a 1-percentage point drop in the overall interest rate will reduce profits by 7% from the range.
But even as the European Central Bank and the Bank of England lower their benchmark lending rates, Europe's unpredictable U.S. trade policies and aggressive spending plans also increase long-term lending costs. The yields in Germany's Bund in two years have fallen by 1.2 percentage points since the ECB first cuts in June last year, but the yields in the 10-year period remained unchanged. This will help limit the decline in commercial banks' profit margins.
The simplest thing is that the business model of banks is to borrow short-term and long-term lending, so the gap between short-term and long-term interest rates is larger - in market jargon, a steep yield curve - means higher potential profits. Over the past decade, the gap has been small or even negative due to weak expectations of long-term growth (called the inverted curve).
Returning to a more normal curve makes things easier for lenders. According to LEX calculations, the gap that lenders usually get on a personal loan of £10,000 and the gap that they pay in a two-year fixed savings account before the Bank of England cuts first-class cuts. By the end of April, that profit margin had risen to 2.8%, interest rates on personal loans rose, while savings accounts fell.
In fact, the process of large banks (managing portfolios with large interest rate swaps to stabilize their income) is more complex, but the end result is the same: higher margins. Banks including BNP Paribas, Casabak and Lloyd have highlighted the potential in recent weeks.
The steep output curve shows that analysts' forecasts are too bearish. The net impact of central bank cuts may remain negative, but KBW's analysis estimates that if short-term interest rates fall while long-term interest rates remain stable, the blow to bank revenue will be reduced by about a third, compared to parallel actions. If the long-term rate increases, the pain will be reduced.
The STOXX 600 Bank Index has risen 30% this year, but even after the climb, it still trades less than nine times its forecast revenue for the next 12 months. As earnings estimates are likely to increase, bank stocks may rise further without increasing valuations, thanks to the help of these margins.
nicholas.megaw@ft.com