Strategies for Banks to Make a Profit in a Low Interest Rate Economy

By Steve Lander

Low interest rates don't have to eliminate a bank's profitability. 

A low interest rate economy can be challenging for the banking sector. After all, if banks earn profit by lending out money and they can't charge as much for the money they lend, it's harder to maintain the same level of profitability. However, low interest rate markets still offer opportunities for banks to do extremely well. These strategies are as open to small community and business banks as they are to the largest institutions. 

Fee Revenue 

Instead of earning money by borrowing and lending money, banks can turn to fees to boost profits. For example, banks can charge overdraft fees when customers try to draw money that they don't have from their accounts. One $35 overdraft fee per year generates as much revenue as lending out $1000 at 3.5 percent for the year. Banks can also charge ATM usage fees, account maintenance fees, statement copy fees and just about anything else they can imagine. 

Origination and Turnover 

Another option for banks is to continually recycle their money, such as in the mortgage market. Instead of making a traditional 30-year mortgage loan and tying up their income for a long period of time, banks can make and sell loans. When the bank makes the loan, it ties up a portion of its capital in the loan at a low interest rate. However, the bank can turn around and sell that loan to an investor and, hopefully, realize a profit on the sale. The bank then has the money back to lend again so that it can continue flipping the funds. 

Changing the Spread 

When the rate that a bank can charge plunges, it creates an opportunity for them to increase their profit by charging a little bit more relative to the market. For example, if mortgage rates should go from 8 percent to 4 percent, it's unlikely that a customer would complain or even notice if the bank dropped its rate to 4.25 percent instead. After all, the customer is still saving a great deal of money relative to previous rates. Doing this helps to cushion the blow of low rates and protect or even increase bank profits. 

Rates Don't Matter 

A low interest rate market cuts both ways. While banks can't charge as much for loans, they also don't have to pay as much to attract deposits. Historical data from the Federal Reserve comparing the prime rate to the rate on a three-month certificate of deposit shows that they trade in a relatively tight band. Between 1995 and 2012, the average difference between the two rates was 275 basis points, and the spread varied between 212 and 320 basis points. When you take out the highest and lowest spread years, the range narrows to 267 to 297 basis points -- which is just over a 10 percent difference during 16 years of the 18 year period. For comparison, during that same period, the prime rate fluctuated from 3.25 to 9.25 percent and CD rates fluctuated from 0.28 to 6.46 percent. In other words, while rates change, the bank's profit, which comes from the difference between the deposit and loan rates, remains roughly similar.

https://smallbusiness.chron.com/strategies-banks-make-profit-low-interest-rate-economy-68922.html