The Federal Reserve’s latest 25 bp rate hike on July 26 has pushed short-term interest rates to the highest level in 22 years. While the current consensus is that rates may have peaked, Fed Chair Jerome Powell’s recent comments suggest that the central bank is not in any hurry to lower rates. In this Q&A, Derivative Path Chief Growth Officer Zack Nagelberg and Chris Slusher, Derivate Path’s Head of Rates, discuss the “higher for longer” rate implications for U.S. banks and borrowers.
Abrigo and Derivative Path have partnered to streamline the origination of customer swaps and increase non-interest income for financial institutions. The integration improves visibility into prospective and existing loans, fostering more swap opportunities.
ZN: What challenges have lenders encountered in this environment of rapidly rising rates?
CS: The dramatic surge in rates over the past 15 months has created several challenges for lenders, including higher deposit costs, losses on their investment portfolios, and reduced loan demand from their borrowers. Lenders also have had to reassess the credit quality of their loan portfolios, given the potential strains that higher rates and a weaker economy may create for their borrowers.
ZN: What are the implications for banks’ funding costs?
CS: In the immediate aftermath of the pandemic, most U.S. banks were flush with liquidity. Loan-to-deposit ratios plummeted to record lows. Banks expected those conditions to persist. However, as rates rose, those excess deposits ran off much faster than anticipated, prompting a renewed focus on liquidity. Banks are being forced to pay higher rates to retain their deposits and are tapping more-expensive wholesale funding sources to meet shortfalls.
ZN: How have banks adapted to these challenges?
CS: Faced with higher funding costs and concerns over a potential economic downturn, banks have widened credit spreads and tightened lending standards.