The aim of this report is to create an awareness of the interest rate which impacts the company. Moreover, the bank recommendations are evaluated whereby interest rate risk is exposed to the bank. There is a recommendation of a rate cut on loans by the bank board along with the growth of loan revenue and thus profit. We have also discussed the strategy to cover any decline in net worth using futures. Our bank, Make Life Easier (MLE) Bank involving the members with their respective ID which are Kok Yee Won (3889479), Lee Choi Yoong (3889459), Ng Mun Yi (3889480) and Sia Cui Lin (3889481).
Bank profit is influenced by the changes in interest rates
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Bank costs and revenue will begin to rise almost immediately with their relative response determining the impact on bank profits as in appendix 3 (Flannery 1980). Therefore, bank’s profits rise or fall depends largely on the average maturity of bank liabilities and assets (Flannery 1980). A market rate change endangers bank profitability only if asset and liability returns adjust at significantly different speeds (Flannery 1980).
Low interest rate increases bank profit
The Federal Reserve has signalled that the interest rate will rise due to a slowing inflation and a sluggish economy (Kopecki 2010). The activities of reduced interest rates in order to boost profits of banking sector had been closed and so banks will start to earn less on investments and loans (Kopecki 2010). Therefore, most banks are finding it hard to earn money including Citigroup, Bank of America (BAC) and JPMorgan Chase (JPM) (Kopecki 2010).
When market interest rates increase, the bank’s profit will also increase as banks fund a part of their interest-earning assets with non-interest bearing liabilities, mainly demand and transaction deposits (English, Heuvel & Zakrajsek 2012).
The net interest margins (NIM) is the net interest income as a percentage of average assets that is the difference between the interest income generated by banks or other financial institutions and the amount of interest paid out to their lenders relative to the amount of their assets (English 2002).
The NIM falls by 17 basis points to 3.15% in Citigroup, 16 basis points to 2.77% in BAC and 26 basis points to 3.06% JPM. (A basis point of 0.01 percentage point) (Kopecki 2010). Furthermore, a reduced in NIM will lead to a drop in net interest income (NII) (Kopecki 2010). The NII was drop of $522 million at Citigroup, $849 million at BAC and $1.02 billion at JPM (Kopecki 2010).
The Reserve Bank of India (RBI) stated that rising interest rate and high cost of funds could hurt the profitability of the banking sector (Business Standard 2012). This is because the credit growth is expected to slow down when hardening interest rate and adversely affect the profitability in banks (Business Standard 2012). Bank’s profitability can be improved by increasing NII though non-interest income remained stagnant (Business Standard 2012). The NII for RBI facilitated was growth of 20% in aggregate net profit of the banking system (Business Standard 2012). The interest income in RBI was raised by 18.6% over 7.5% in and interest expense was raised by 10.1% over 4.0% in 2010 (Business Standard 2012).
Low interest rate decrease bank profit
Bank profit will fall if the interest rates increases and bank costs are more rapidly than loan revenues (Flannery 1980). Household and government consumption and investment will increase when interest rates fall (Norges Bank 2003).
Therefore, in our opinion, the bank board’s recommendation of reducing rate on loans in order to increase loan revenue and profit is valid....