The rate that the Federal Reserve pays on bank deposits, called the Interest on Excess Reserve Rate (IOER), is currently at ten basis points and will be the subject of an interesting discussion at the upcoming Fed Open Market Committee Meeting this week. At the end of last week, the Fed Funds effective rate was four basis points which could be a problem.
Net interest margin (NIM) is one of the most over-utilized metrics in banking. As we have pointed out in the past, if you include all the failed banks over the last ten years, the statistic is about 20% predictive of underperformance. Thus, if you manage your bank trying to get the largest NIM possible, you are likely to produce less profit, not more. Of course, all things being equal you want wider NIM loans than not, but all things are rarely equal.
While it is debatable when the Fed will raise interest rates, we now know we are getting closer. In all likelihood, October marks the end of the Fed’s Quantitative Easing Program and now the question is just how the Fed will reverse a large portion of the $4.4T of investment that sits on our Nation’s balance sheet. Of greater interest to banks is what mechanisms the Fed will use and what banks need to know to take the best advantage of the unprecedented size of the liquidity reversal.
