Receive free UK banks updates
We’ll send you a myFT Daily Digest email rounding up the latest UK banks news every morning.
UK banks are seizing on rising interest rates to improve profits by charging borrowers more for loans. But the boost may be shortlived as bad debt starts to creep upwards, competition for deposits intensifies and political pressure mounts for the windfall to be shared with inflation-stricken savers.
“It is not unreasonable to conclude that, in a UK context, we have now crossed the inflection point where the negative consequences of higher rates . . . outweigh the positive,” John Cronin, financials analyst at Goodbody, wrote this week.
The Bank of England base rate, the interest financial institutions receive on money held at the central bank, is now 5 per cent. While the average interest charged on a two-year fixed-rate mortgage has risen to 6.26 per cent, the average easy-access savings account pays only about 2.36 per cent, according to data provider Moneyfacts.
Martin Lewis, a consumer rights campaigner and founder of advice site MoneySavingExpert, wrote on Twitter last week that “the fact that banks are only fully passing rate rises on to borrowers not savers is counterproductive and profiteering”.
Harriett Baldwin, chair of the Commons Treasury committee, said that “in a high interest rate environment, banks have a duty to encourage saving”, adding that one of the transmission mechanisms to tame inflation was for savers to feel a benefit.
About 60 per cent of household deposits are held in interest-bearing instant access accounts that typically have a variable rate, according to the BoE’s Monetary Policy report in May, which noted that “the pass-through to these accounts has been unusually weak over the tightening cycle”.
One key measure of profitability under scrutiny is net interest margins — the difference between the interest banks charge on their loans and the rate they pay on deposits.
While average NIMs among big UK banks fell from 3.12 per cent in 2015 to 2.59 per cent in 2020 as interest rates were further slashed during the pandemic, they have since recovered as interest rates rebounded, according to a 2022 analysis by the Financial Conduct Authority.
Barclays’ UK net interest margin rose to 3.18 per cent in the first quarter of 2023 from 2.62 per cent in the same period last year, while Lloyds Banking Group’s increased to 3.22 per cent from 2.68 per cent a year earlier. HSBC UK’s was 1.89 per cent at the end of last year, up from 1.53 per cent in 2021.
But the gap between what banks charge borrowers and what they pay savers may have reached its limit. As consumers grapple with a cost of living crisis, banks have started to suffer deposit outflows as customers hunt for better savings rates and lock up their money for longer. Lloyds said its total deposit base of £473bn at the start of the year fell by £2.2bn in the first quarter.
Bank analysts believe the positive uplift of rising rates has now run its course and the sector is at a tipping point.
“One of the bull cases for the UK banks has been the transformation in net interest income,” Guy Stebbings at BNP Paribas Exane wrote in a recent note, referring to the difference between the total interest paid to depositors and the revenue received from making loans. “But as deposit competition steps up pace and mortgage spreads remain under pressure, given limited demand and challenges to pass on rates to customers, this narrative is turning on its head.”
Banks reject accusations of profiteering, saying the calculation of net interest margin is complex and includes the mix and composition of the bank’s loan book. Fixed-rate mortgages are usually tied to swap rates that move in anticipation of the BoE base rate rather than being tied to its actual level, they say.
They point out that instant-access accounts pay a lower rate because savers can withdraw money without notice, which can leave banks scrambling to replace retail deposit funding.
They also argue the margin is needed to cover other costs in the business and say there is little profitability in the mortgages market.
“You have to spend millions on anti-fraud measures and bank branches,” said one senior banker, adding that instant access accounts “are not profit centres”.
In a recent letter to the Treasury select committee, the Financial Conduct Authority acknowledged that “assessing whether increases in net interest rate margin and associated profits have been disproportionate is very complicated”, but it made clear that its new “consumer duty” would require businesses “to be able to justify and explain the rationale for the speed with, and degree to which, they make changes to their various savings rates”.
Banks have signalled that their net interest margins will be lower this year.
NatWest Group chief executive Alison Rose told a Goldman Sachs conference in June that she expected the bank’s net interest margin to be about 320 basis points this year. “In Q1 it was higher at around 327. We would expect NIM to continue to reduce,” she said, adding that “overall impairments remain very, very low at this point”.
Lloyds Banking Group chief financial officer William Chalmers said in May that NIM would decline in the second quarter and was expected to be in excess of 305 bps in 2023, “given expected headwinds from mortgages and deposit pricing”. Barclays UK said it expected NIM to be above 320 bps for the year.
Analysts caution that this point in the economic cycle is about as good as it gets for the sector because banks are now expected to pay higher savings rates as they compete more aggressively for retail deposits. Bad debts are expected to increase in the economic downturn as consumers and businesses struggle to repay loans at higher rates.
Investors warn that further rate rises will weigh on the UK economy and therefore bank stocks.
Guy de Blonay, a fund manager at Jupiter, said this would have “negative implications for the UK banks as risks to capital returns and asset quality intensify”. He added that he now had “a cautious view on the outlook for UK banks over the next 12 months”.
Bruno Duarte, a fund manager at Algebris Investments, said the guidance from most banks was that “the peak in net interest margins may be around the corner”.
But he added that banks should be able to weather the economic storm, given that “for the average national champion bank the incremental increase in net interest income from higher rates alone is around twice the projected loan losses for this year”.
