Inflation is often viewed as a positive for banks, as it increases net interest revenue and profits. However, top bankers caution that if inflation rises too quickly, it might become a drag.
Inflation, according to Goldman Sachs Chief Operating Officer John Waldron, is the most serious threat to the world economy and stock markets.
Last month, JPMorgan Chief Executive Officer Jamie Dimon told analysts that rising inflation and high interest rates raise the potential of dramatic price fluctuations, and that banks “should be concerned.”
According to one senior banker at a European bank with significant U.S. operations, a sustained period of higher inflation would pose credit and market risk to banks, which they are examining in internal stress tests.
Another banker said risk teams are also keeping an eye on loan exposures in the sectors most hit by inflation. Companies from the consumer discretionary, industrial, and manufacturing sectors are among them.
“We’re quite engaged with those clients, giving hedging protections,” the banker added, declining to be identified because client conversations are private.
Clients who may want additional cash to get through a period of rising inflation are encouraged to raise capital while interest rates are still low, according to the banker.
“If you need money, it’s still a great atmosphere to be in, but it won’t stay forever.”
Higher inflation and monetary tightening are also being considered by investment bankers as potential disruptions to record deals and public offering pipelines.
“We expect higher inflation to persist, and monetary tightening might hinder the M&A market’s momentum,” said Paul Colone, managing partner of Alantra, a global mid-market investment bank based in the United States.
“Evaluate the risks sustained inflation could bring to both value and business results,” Colone said. Alantra advises clients in the early phases of M&A conversations to “review the risks sustained inflation may bring to both valuation and business results.”
Meanwhile, sales and trading teams are receiving increasing calls from clients trying to reposition portfolios that are at risk of losing value. When inflation became uncontrollable in the 1970s, stock indices in the United States took a beating.
Chris McReynolds, Barclays’ head of U.S. inflation trading, said, “We’re seeing greater interest from clients in obtaining some kind of inflation protection.”
Inflation in the Treasury Protected Securities, which are issued and backed by the US government, are becoming increasingly popular, according to him. The securities are comparable to Treasury bonds, but they are inflation-protected.
Traders are also seeing an increase in demand for derivatives that provide inflation protection, such as zero-coupon inflation swaps, which exchange a fixed rate payment on an investment for a payout based on the rate of inflation.
“People are recognizing that they are exposed to inflation and that it makes sense to hedge their assets and obligations,” McReynolds said.
Most observers believe that banks with varied businesses will benefit best during a prolonged period of inflation.
They forecast a steepening yield curve to boost overall profit margins, while trading businesses will gain from greater volatility and deal strength, and investment banking activity will stay solid due to IPO pipelines.
Dick Bove, a well-known independent banking analyst, has a different perspective. He expects the yield curve to flatten as interest rates rise, lowering inflation expectations and squeezing company margins.
“Bank stock prices may soar for as long as 12 to 18 months,” he said. “However, if inflation continues to climb, bank stock multiples will fall, and bank stock prices will follow.”
Is a high rate of inflation beneficial to bank stocks?
Consumers, stocks, and the economy may all suffer as a result of rising inflation. When inflation is high, value stocks perform better, and when inflation is low, growth stocks perform better. When inflation is high, stocks become more volatile.
What effect does inflation have on bank stocks?
Inflation has the greatest impact on the value of fixed-rate debt securities since it devalues both interest rate payments and principal repayments. After correcting for inflation, lenders lose money if the inflation rate exceeds the interest rate. This is why investors sometimes look at the real interest rate, which is calculated by subtracting the nominal interest rate from the inflation rate.
What happens to banks when prices rise?
They lose because they are net monetary creditors. However, they benefit as demand deposit issuers. The second effect may easily outweigh the first with more indexing and more accurate forecasting of future inflation.
Bankers have recently learned to recognize and manage interest rate risk. Bankers learned of the need to hedge their balance sheets against this risk by applying duration analysis, thanks in large part to the efforts of the editor of this journal in a series of articles in American Banker. The duration of equity (a value-weighted average of the durations of assets and liabilities) was set to zero to protect the bank from interest rate risk. With this position, the bank was considered to be immune to modest changes in interest rates. However, this immunization technique only safeguarded the bank’s nominal market value, not its real market value that is, the bank’s market value in today’s dollars, not the bank’s market value in inflation-adjusted dollars. This post aims to start a conversation on how to correct this oversight.
Do banks profit or lose money as a result of inflation? Is it the rate of inflation or the rate of change that matters? Is the impact of pricing changes symmetric? Is it true that disinflation has the same but opposite effects as inflation? What role do expectations play in the process? Is it possible for banks to avoid these consequences?
We’re mostly interested in the impact of shifting prices on net interest income and capital values here. The impact of inflation on noninterest revenue and expenses, as well as the real resource production function of banks, will be discussed in future articles. This latter assumption equates to the plausible (but controversial) belief that actual (inflation-adjusted) noninterest revenue and expense are unrelated to price changes for the purposes of this article.
The focus is on how inflation affects banks, rather than how banks have been affected by specific inflations. As a result, we exclude factors such as increased bank competition and regulatory changes (both of which have a significant impact on bank earnings), as these are not always caused by inflation.
We start by going over the economic literature and the basic “overview” ideas. We then show how both theories are subsets of a broader approach whose major components are rates of change in expectations and portfolio adjustment speeds. The more comprehensive hypothesis serves as a foundation for future research.
In the economics and finance literature, the impact of inflation on actual bank earnings has been extensively explored. There are two competing and opposing models. Banks, according to Alchian and Kessel (A-K), are net monetary creditors (i.e., their nominal assets are greater than nominal liabilities). As a result, rising prices would reduce the value of their nominal assets more than their nominal liabilities. As a result, banks will lose money during an inflationary period.
The inflation tax school, on the other hand, argues that because banks’ demand deposits account for a component of the money supply, they should be able to capture a piece of the inflation tax and so profit during an inflation….
Is now a good time to invest in bank stocks?
The heavily regulated banking business in Canada generates significant entrance hurdles. This is extremely similar to the telecom industry in Canada.
The Big 5, as well as smaller regional firms like the National Bank of Canada (NA) and Canadian Western Bank, are vital to the Canadian economy (CWB).
A Canadian bank stock might be a good addition to one’s portfolio because it is low-risk, offers growth, and pays a consistent dividend.
Canada’s banks were among the first to reinstate an increasing dividend after weathering the financial crisis better than almost all other global banks. The Bank of Montreal, in fact, has one of the country’s longest dividend payment streaks, having paid dividends since the early 1800s.
Are banks a smart way to protect against inflation?
Inflation isn’t necessarily a bad thing for everyone. When prices rise, some firms fare better. As interest rates rise, banks normally make more money because they may benefit from a bigger margin between what they charge for loans and what they pay out for deposits. During inflationary periods, companies with low capital requirements and the potential to raise prices are frequently the best positioned. These companies can keep and grow their profits without needing to reinvest significant sums of money at ever-increasing prices.
Warren Buffett, the legendary investor, famously claimed that in an inflationary environment, an unregulated toll bridge would be his favorite thing to own since you would have already built the bridge and could raise charges to combat inflation. “If you build the bridge in old dollars, you won’t have to replace it as often,” he explained.
Where should I place my money to account for inflation?
“While cash isn’t a growth asset, it will typically stay up with inflation in nominal terms if inflation is accompanied by rising short-term interest rates,” she continues.
CFP and founder of Dare to Dream Financial Planning Anna N’Jie-Konte agrees. With the epidemic demonstrating how volatile the economy can be, N’Jie-Konte advises maintaining some money in a high-yield savings account, money market account, or CD at all times.
“Having too much wealth is an underappreciated risk to one’s financial well-being,” she adds. N’Jie-Konte advises single-income households to lay up six to nine months of cash, and two-income households to set aside six months of cash.
Lassus recommends that you keep your short-term CDs until we have a better idea of what longer-term inflation might look like.
How can I plan for inflation in 2022?
With the consumer price index rising at a rate not seen in over 40 years in 2021, the investing challenge for 2022 is generating meaningful profits in the face of very high inflation. Real estate, commodities, and consumer cyclical equities are all traditional inflation-resistant assets. Others, like as tourism, semiconductors, and infrastructure-related investments, may do well during this inflationary cycle as a result of the pandemic’s special circumstances. Cash, bonds, and growth stocks, on the other hand, look to be less appealing in today’s market.
Do you want to learn more about diversifying your investing portfolio? Contact a financial advisor right away.
What are the ways that banks profit from inflation?
- Inflation is defined as an increase in the price of goods and services that results in a decrease in the buying power of money.
- Depending on the conditions, inflation might benefit both borrowers and lenders.
- Prices can be directly affected by the money supply; prices may rise as the money supply rises, assuming no change in economic activity.
- Borrowers gain from inflation because they may repay lenders with money that is worth less than it was when they borrowed it.
- When prices rise as a result of inflation, demand for borrowing rises, resulting in higher interest rates, which benefit lenders.