Rising interest rates can be good or bad news for bank stocks — sometimes both at the same time. Banks can earn more money when they can charge more for loans, but borrowers may want fewer loans, which can depress profits. Also, banks must pay more when they borrow funds. Finally, banks’ portfolios of bonds usually decline in value when interest rates rise, which can harm the bank’s balance sheets and cause investors to shy away from them. Individual banks may do better or worse when rates rise, depending on their specific markets and business model.
To figure out how bank stocks could fit into your plans, consider working with a financial advisor.
Recent Bank Stock Performance
A little more than a year after the Federal Reserve began hiking interest rates on March 16, 2022, one broad-based measure of bank stocks showed how rates can negatively affect shares of banking companies. The S&P Banks Select Industry Index, which tracks shares of 94 banks and other financial services institutions with market caps that range from less than $1 billion to $382 billion, was down 28.86% in the year ending March 30, 2023. While this was a challenging period for stocks in general, the S&P 500 Index of 500 large firms in diverse industries was down a more modest 9.29% for the same period.
This poor showing by bank stocks during a year of rate hikes contrasts with a positive annualized return of 11.51% for the previous three years. That period includes two years of stable interest rates and relatively good price performance before the rate hikes started.
This general trend is in addition to the singular failures of two large institutions, Silicon Valley Bank and Signature Bank, which were shut down by regulators during March 2022. These banks were victims of runs by depositors who rushed to withdraw funds after concerns about the banks’ stability arose.
How Interest Rates Affect Bank Stocks
The interplay between bank stocks and interest rates is not perfectly straightforward, however. Higher rates can both benefit and imperil banks. Here are some major factors affecting how bank stocks respond to interest rates:
- Higher lending profits. Banks make money by lending money and their profit margins may rise when they can charge more to borrowers, which naturally helps buoy banks shares.
- Less loan demand. When loans costs more, borrowers are less interested in borrowing, which can depress bank shares. Also, rate hikes tend to depress overall economic activity, which can further reduce loan demand.
- Higher borrowing costs. Banks don’t just lend money. They also borrow from various sources, including the Federal Reserve, which manages overall rates by increasing the rate it charges to member banks for borrowing from it. Depositors, too, want higher rates on savings accounts and certificates of deposits, so banks have to pay more to remain competitive.
- Bond portfolios. Banks can’t lend out all the money they have. They must hang onto some of their total capital as a reserve. These reserves are typically invested in bonds, which tend to decline in value when rates rise – especially if those bonds are hold-to-maturity fixed-income securities. If the value of these reserves declines enough, it can make banks vulnerable to customer withdrawals, trigger regulatory scrutiny and, potentially, being shut down. Investors who see declining reserves often unload bank stocks, causing prices to fall. The problems at Silicon Valley Bank, Signature bank and First Republic, for example, were caused in part by steep declines in the value of their portfolios of bonds, which limited their ability to raise money to pay off depositors when bank runs gathered momentum.
Interest rates aren’t the only economic factors that affect banks. For instance, central banks tend to increase rates when economies are strong, because strong economies tend to bring about inflation. Loan demand tends to be strong when the economy is, so for a while at least when rates rise some banks may enjoy continued good demand for their relatively high-priced loans.
Also, much depends on the circumstances of individual banks. For example, Silicon Valley Bank failed while nearly all other banks survived the challenging economic climate, in part, because it had as customers a higher-than-average percentage of venture capitalists. At the same time shares in the more-diversified JPMorgan Chase & Co., the nation’s largest bank, were down only about 4% during the year after the rate hikes started. That’s much less than the S&P bank index and better than the overall stock market performance.
The Bottom Line
Banks and interest rates have a complex relationship that includes the opportunity to earn more profit from lending when rates rise, but only if they can overcome the obstacle of higher borrowing costs for their own funds. The round of rate hikes that began in March 2023, along with other influences, has led to a steep decline in the value of the typical bank stock. This suggests that most banks, in the eyes of investors, are not being helped by higher interest rates. However, broad characterizations of the impact of rising rates on bank stocks may be inaccurate in the case of individual stocks.
- To better understand how investing in banks and financial services companies can play a role in your portfolio, consider talking to a financial advisor. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Interest rates affect far more than bank stocks. The SmartAsset guide to interest rates shows how rate trends impact many aspects of your personal financial life, from the cost of a new mortgage to the return on your savings account.