Has the windfall from rising rates already peaked for UK banks?

For more than a decade following the financial crisis, UK banks endured a painful wait for interest rates to rise, counting down the days until they could finally start to make money from their customers’ deposits.

Surging inflation granted their wish.

Since late 2021, and as the Bank of England pushed up the base rate fast to grapple with soaring prices, banks enjoyed a rapid increase in net interest margins — a measure of the difference between the interest received on loans and the rate paid for deposits.

But this month, as they announced their full-year results, the UK’s biggest lenders suggested that the long-awaited windfall might be shortlived. NatWest and Barclays both guided that NIM for 2023 would be close to the level it hit in the last quarter of 2022, while Lloyds said that it would fall slightly. HSBC did not give guidance on NIM, but said that its net interest income would also remain at roughly the level it hit in the fourth quarter.

The fear is that bank profits will suffer as consumers start to demand higher rates on their savings, while competition builds in the mortgage market and from deep-pocketed US rivals, leaving analysts and shareholders disappointed.

“In broad terms there’s a feeling they’re at peak NIM, falling back through 2023,” said John Cronin, an analyst at Goodbody.

The BoE has increased its base rate 10 times since December 2021 in the face of post-coronavirus inflation, worsened by Russia’s invasion of Ukraine. It reached a 15-year high of 4 per cent at the start of February.

“Interest rates moved up very quickly,” said Omar Keenan, analyst at Credit Suisse. “We haven’t seen the hiking cycle like this in some time.”

But further rate rises are uncertain. On Wednesday, Citigroup forecast that inflation would be down at around 2 per cent by the end of the year.

In February, the BoE said further rises would only be needed if there were new signs that inflation was going to stay too high for too long, although a member of its Monetary Policy Committee said on Thursday that rates would need to rise further.

The end of the rate rise cycle is not the only thing squeezing banks’ NIMs.

The cost of living crisis is also driving consumers to look for better savings rates, with some movement from current and instant access accounts to higher earning deposits, making them more expensive for banks.

“We’re seeing a bit of a start of a change in customer behaviour,” Alison Rose, chief executive of NatWest, said last week, “[with] some customers starting to put more into term accounts.”

Keenan said that a return to longer-term deposits would mark a normalisation in customer behaviour, after years in which low interest rates depressed savings rates across products, removing the incentive to lock up cash for a year or more.

High street lenders are also facing greater pressure from those trying to crack the market which are offering better rates in an effort to boost their deposit base. Chase UK, JPMorgan’s international digital bank now offers an instant access account with a rate of 3 per cent.

The standard rate of interest offered by large high street lenders for most easy-access savings accounts is currently less than 1 per cent, according to the finance website Moneyfacts.

More competitive rates typically only apply to smaller amounts, or have conditions such as not making withdrawals in a given month.

Although people have traditionally been slow to move their bank deposits in the UK, the cost of living crisis has made competitors such as deep-pocketed Chase more attractive.

“You saw competition around savings pick up in the last quarter of 2022,” said Charlie Nunn, chief executive of Lloyds Banking Group. “We expect that to continue throughout 2023.”

Political pressure from politicians could also hit margins. Executives were grilled by MPs at the House of Commons Treasury select committee earlier this month, over accusations of failing to pass on the benefits from rising rates to consumers.

“They’re a bit nervous,” said Cronin.” We did see rates creep up a bit before the Treasury select committee hearing.”

Yet another drag on NIMs in 2023 could come from the changing mortgage market.

While much of the chaos which followed the “mini” Budget in September has subsided, mortgage rates remain substantially higher, and economic uncertainty is also damping demand.

Overall, lower demand for mortgages meant a “very competitive environment” said Barclays group finance director Anna Cross in an analyst call, with a particular impact on higher loan-to-value mortgage, which have better margins.

Keenan said that in the low interest rate environment during the first years of the pandemic, banks sold mortgages where repayments were 150 to 180 basis points above the swap rate, which banks use to mitigate interest rate risk. Today, with the greater competition, that has decreased to 80 basis points.

For lenders competing in the mortgage market, the risk of overstretching customers with little financial wriggle room, given higher energy and food costs, will also make it hard to push up rates.

“Pressures facing households with mortgage rates picking up materially and a risk to arrears bills later in the year will put a ceiling on how far spreads can widen,” said Cronin.

The risk that we have reached peak NIMs comes as UK banks are still looking to convince investors that they make good bets, after years of partially self-inflicted troubles.

“After the financial crisis, you had regulatory requirements go up, and you had major litigation and conduct issues,” said Keenan. “That’s still fresh in the memory of a lot of investors.”

But despite the disappointment that rising rates may not provide as much of a boost as hoped, banks still look set to weather a worsening economy in 2023.

“You’re going into a recession, with banks all guiding to double-digit returns at levels we haven’t seen for 15 years,” said Ian Gordon at Investec. “With costs flattish and margins stabilising around 2022 year-end levels, the picture of profitability is quite striking.”