Interest rates increased after almost a decade

So Finally FOMC increased the interest rates this week by .25% after almost a decade as expected. Though it was fixed since 2008 at 3.25%, June 2006 was the last time it was increased.

Federal Open Market Committee (FOMC) mandate is to determine the prime interest rate & money supply.It was formed through the  Banking Act of 1933 & were supposed to meet four times a year. However since 1981, they are meeting every five to eight weeks at least 8 times a year to fulfill the same mandate.

Federal_Open_Market_Committee_Meeting

Increase in interest rate indicates confidence in the economy by the Feds. Although they would be aiming for much higher increase, this increase would be a litmus test to see how far can they stretch. Higher interest rate means it is expensive to borrow money driving valuations of assets down. For a common man, increased mortgage rate makes it less affordable to own a house.

This increase in interest rate was expected and overdue. A twitter survey indicated mixed result as below.

Screen Shot 2015-12-16 at 7.41.49 PM

Increase in interest rate will strengthen the dollar because it attracts more investment in the country. Investors can earn more money by keeping their money in saving accounts in US and demand of US dollar goes up. Interest rates are still very low. Just as a comparison it was 21.5% on December 19th 1980. Following is the graph of interest rates since 1947.

Interest Rates

We are living in economy of 3.25 prime rate for the last 7 years. Higher interest & dollar rate have negative impact on international loan-burdened economies . They are already struggling with repayment of loans & now they have to pay even more. On the flip side, it will make it difficult for US vendors to sell internationally because their product have became more expensive and the competing products from other countries have became cheaper. At the moment, effects would be minimal but it would be interesting to watch out for their next meeting on January 27 & 28.

Looking forward to post 3.5% economy.

2016-03-06T15:46:03+00:00December 18th, 2015|

Will FOMC end the history’s longest interest rate freeze tomorrow ?

Prime rate is the interest rate at which bank is suppose to lend money to their best customers. It is set as a reference to determine what are the best possible terms at which some one can get interest. In actual, interest rates could either be higher or lower than the prime.

Federal Open Market Committee (FOMC) mandate is to determine the prime interest rate & money supply.It was formed through the  Banking Act of 1933 & were supposed to meet four times a year. However since 1981, they are meeting every five to eight weeks at least 8 times a year to fulfill the same mandate. FOMC is meeting again today and tomorrow to see if any changes are required before the next meeting in January 26-27th.

Federal_Open_Market_Committee_Meeting

Interest rates are frozen at 3.25 since Dec 16th 2008. As a reference, it peaked at 21.5% on December 19th 1980. This is the longest unchanged interest rate in the history.

Here is a historical data on interest rates.

 

Interest Rates

With such low interest rates, it is becoming more and more difficult for banks to offer saving accounts. Margins are shrinking for them and people are looking for alternatives to get higher returns. Lower interest rate is responsible for the higher valuations of companies & real estate.

Technically any deposits in saving accounts is the money lent by banks to lend it further. If they are unable to lend it faster than they are getting deposits, they have to pay interest from their own balance sheet. This is why banks are allowed to lend up-to 9X of the deposits they have. Just as an example for every $10, they can lend up-to $100. Bank with higher lend to deposit ratio will always have a healthy P/L statement.

Higher interest rate will hurt the banks with lower lend to deposit ratio.

There is a high probability that this meeting will end the longest interest rate freeze, it would be a good news for bank stake-holders. It would for sure lower down the demand for capital since it is more expensive to borrow, however will also correct the market valuations. Not correlated, but the oil price have rebounded above $35 for the first time since 2009.

Let’s wait till tomorrow to see if there are any changes announced.

2016-03-06T15:44:51+00:00December 15th, 2015|

FinTech startups don’t want to be a Bank

Banks are boring & claim to be next generation bank is rarely heard in startup world. Banks were born out of need to store the cash safely.  Banks generally have a very good perception of trust & security among masses which led to position themselves as one-stop shop for anything financial related. Over time they built the brand , distribution & resources to up-sell other financial products such as loans, insurance, money transfers etc.

As any other business, competition have started to hurt the banks. However, new entrants are not keen to attack the core competency of the bank i.e holding people’s money. The main reason behind lack of competition is the resource intensive regulatory process. With low ROI. it’s not worth the effort for startups. Although bank fees brings lot of revenue to the bank, holding money is not profitable. It’s more of a liability than an assets.

Startups will take away the profit-making products of banks leaving them with liabilities to hold cash only

When it comes to retention, banks are doing really good job. When was the last time you changed the bank ? As per a survey, approximately in any given year 3% of people change bank. While 57% of the people are with their bank for last 10 years, 37% people are still trusting their bank even after 20 years.

For startups, it is easy to launch other financial products due to less barrier to entry in terms of regulations. In no specific order, popular products are

  • Lending
  • Remittance
  • Bill payments
  • Credit card processing
  • Insurance
  • Hedge funds
  • Credit cards

Lending being the most popular product, FinTech startups are focused on creating the most efficient P2P lending marketplace. As per Goldman Sach estimate, 20% of bank lending will move to alternative finance, costing 12 billion dollar in profit loss for the bank. This is 7% of total profits for the banking sector.

Over next few years, due to regulation burden, number of players in banking will reduce. More and more consolidation will happen in the industry due to shrinkage of profit margins. Industry have already started to search for solutions to sustain their retail locations with reducing operational expenses and innovating to compete with startups in term of products & services. Though they have an edge in term of resources, corporate culture makes it difficult to innovate.

It a race between Innovation vs distribution as beautifully written by Alex Rampell .Will FinTech startups be able to get the distribution first or banks will be able to innovate first ? Race is ON.

2016-03-06T15:46:14+00:00December 3rd, 2015|