So it appears as though the “new abnormal” of low (and negative) interest rates is with us for the foreseeable future.
On July 31, for the first time in a decade, the U.S. Federal Reserve cut interest rates by 25 bps to 2%. In a statement, the Fed noted it comes in response to an uncertain global economy and “muted” inflation in the States.
On September 3, the Reserve Bank of Australia held its interest rate at 1%, despite calls for further cuts. Two 25 bps cuts are expected by April 2020.
On September 12, the European Central Bank (ECB) trimmed interest rates by 10 bps to -0.5%, the lowest level ever and the first rate change since 2016, citing a sluggish European economy, Brexit and trade wars as key concerns. The ECB also indicated that rates would remain at current levels until inflation hits 2%. Plenty of countries have historically low interest rates already, with some even going into negative interest rate territory — among them, the ECB, Switzerland, Denmark, Sweden and Japan.
Three pricing implications for banks
#1: Margin compression. With reduced interest rates comes margin compression and lower net interest income. Obviously, this is far from good news for banks, and they know it. In a recent earnings call, Darren King, CFO of M&T Bank said: “The interest rate environment has become more volatile than at any point in recent memory, impacting our outlook for net interest margin and spread revenues.” M&T noted that for each 25 bps reduction in the Fed rate, the bank would see additional downward pressure of 5-8 bps on its net interest margin over the next 12 months.
#2: Repricing deposits. While lending arrangements are often set relative to a market reference or benchmark, existing contract structures constrain banks from repricing deposits that have already hit a floor, also leading to margin compression and lower Net Interest Income.
#3: Negative interest rate scenarios. To alleviate pressures from negative interest rates, European banks are looking to charge corporate clients for deposit holdings. However, legacy applications are not architected to process negative rate scenarios, including calculating fees paid on deposits and interest received on loans.
By externalizing key pricing capabilities from product processors, Zafin product and pricing control platform enables banks to respond strategically and efficiently to the low interest rate environment:
- Increase the sophistication of pricing strategies by transitioning from an indexed rate to managed rate pricing terms and conditions.
- Balance profitability targets and thresholds with effective product planning.
- Enhance the flexibility and agility of pricing execution, including negative rate scenarios.
- Optimize non-interest expense with granular, behaviour-based microsegmentation.
- Increase fee income to supplement reduced lending revenue.
- Manage the profitability of a client as a whole in relation to the client’s deposit portfolio.
- Reward your best clients with holistic relationship pricing.
Heading to Sibos 2019 in London? Interested in learning more about how you can respond to the low interest rate environment with Product and Pricing Control? Book a meeting with the Zafin team.