The US Fed Reserve moved to lower interest rates to zero overnight, in what was the largest single-day rate cut since the Global Financial Crisis (GFC).
If interbank interest rates in Singapore were to decline in tandem, then Singapore banks may find themselves lending out money at lower interest rates (read: that's cheaper housing loans for you).
For banks, that could mean earning less for every loan made.
As such, the latest Fed rate cut seems like bad news for our local banks.
But there are more factors to consider.
NOT THE FIRST TIME RATES ARE ZERO
The Federal Funds Rate is the interest rate that banks charge to lend reserves (funds held at the Federal Reserve) to each other overnight.
Singapore's version is the SIBOR, or Singapore interbank offered rates.
This is not the first time interest rates have been reduced to near-zero.
In fact, for much of the decade prior to 2017, the SIBOR had remained below the 1 per cent mark.
Notably, there was a sharp decline in interest rates during the GFC, where the SIBOR declined from around 3.5 per cent in 2007 to less than 1 per cent in 2009.
The fall was steep, to say the least.
GRADUAL, NOT DRASTIC
When it comes to the banks, the decline in interest rates does not impact the bank's net interest margin (NIM) in the same manner.
Take Oversea-Chinese Banking Corporation or OCBC for instance.
The decline of OCBC's NIM was more gradual, starting from 2009 before flattening out starting from 2013.
Said another way, history informs us that it usually takes time for a major rate cut to make its way through the bank's portfolio of loans.
Interestingly, OCBC actually grew its net income despite the lower NIM.
GET SMART: NOT THE ONLY FACTOR
Low-interest rates may hamper a bank's ability to earn more net income.
But that's not the only way banks earn their keep.
Banks can also earn non-interest income by providing services such as wealth management, life assurance, fund management, brokerage, credit cards, trading, and more.
For context, OCBC earned over 40 per cent of its total income from non-interest income sources for 2019.
That's on the positive side.
On the other end, OCBC is expecting loans from industries hit hard by the coronavirus such as hospitality, retail, and transport to come under pressure. Secondary impacts could also be felt in manufacturing.
Meanwhile, with oil prices crashing last week, it is also possible that loans by oil and gas companies will also be negatively impacted. But the extent is unknown at this point.
We'll find out more when our local banks report in the coming quarter or during the mid-year. Stay tuned.
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This article was first published in The Smart Investor. All content is displayed for general information purposes only and does not constitute professional financial advice. Disclosure: Chin Hui Leong owns shares in OCBC