UK banks would welcome BoE rate rise

Following a lacklustre reporting season, UK bank shareholders look forward to monetary policy tightening, says Rob James, manager, Old Mutual Financials Contingent Capital Fund, and financials analyst, Old Mutual Global Investors

This has been a tough reporting season for the UK banks, but for very predictable and hopefully short-lived reasons.

Low interest rates and a lack of volatility due to quantitative easing have given the sector revenue headwinds, compounded by the investment spend required to bring customer-facing systems into the real digital age. Profits, of course, get squeezed in the middle. The positive, again, has been the lack of bad debts, brought about by the very high levels of employment in the economy.

So how do they get out of this malaise?

Interest-rate rises will help. Banks make money from the spread between what they pay for deposits and what they earn on loans. As rates fell towards zero, there was also a fall in loan rates, many of which were linked to benchmark interest rates – but the price of deposits was effectively limited at zero. We haven’t yet in the UK reached the point where depositors have to pay for the privilege of placing their deposits in the bank, unlike in some areas.

We expect the Bank of England (BoE) to raise rates this week. When it does, banks will be able to reprice their loans upwards and widen their margins. This isn’t usury – banks have been subsidising their depositors at the expense of their shareholders – it’s ironic really, given that their shareholders, by and large, are the same people in the form of pension savers. At the same time, the BoE’s cheap-money programme, the Term Funding Scheme, will also come to an end in the coming months, removing a distortionary effect in the market.

The effect is that, rather than dreading a small, measured increase in base rates, we look forward to it. At least as bank shareholders, anyway.