For the majority of bankers, maintaining or increasing net interest margin (NIM) is the single most significant focus today. The shape of the yield curve and lower rates have caused NIM compression across the board and have hurt bank equity performance. While we are not big fans of managing bank performance using NIM as it doesn’t take into account risk and cost, it is one of the most common performance metrics used in banking.
We recently discussed how banks should be treating interest rate floors. Today we want to cover the converse structure – the interest rate cap. We are going to review how banks are using caps on loans and how some banks have been using balance sheet caps to manage interest rate risk. We will share some general observations and our recommendations.
What is an Interest Rate Cap?