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How Does Inflation Affect The Banks?

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Bloo Loo just made a comment on another thread:

The problem is that bankers can see IO NOT returning their capital in real value, with inflation at 5% and interest at the same...the bank is LOSING money on every deal.

I've never thought about this in the past, or even heard it discussed here. However, I realised that level of inflation must be a fundamental, key determinant in mortgage availability and pricing.

If inflation is running at, say 4%, lending at a rate less than that is always a losing proposition. The bank would obviously raise interest rates and lower LTV and term to depending on their long term outlook on interest rates.

More importantly though, in a high interest rate environment, the underlying captial will be inflated away much more.

Therefore, a 1% rise in inflation, all else being equal, should result in a > 1% rise in repayment mortgage rates to cover the interest plus devaluation of the capital.

Is my analysis correct, in that this makes the whole system extraordinarily sensitive to the long term inflation outlook?

Could someone expand on this for a bear of little intelligence trying to get a handle on the variables?

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Maybe she would be correct if the banks were lending their own money however they are lending depositors money and it is the depositors that are getting screwed by high inflation low interest rates.

Generally when that happens depositors would remove their cash and put it into something else or just spend it, doing so would increase interest rates. That is the case in countries with say 20% inflation and 10% bank rates. However in the UK with say 4% inflation and 2.5% interest rates people don’t mind or don’t feel a 1-2-3% loss in capital to be that big a deal.

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If inflation is running at, say 4%, lending at a rate less than that is always a losing proposition. The bank would obviously raise interest rates and lower LTV and term to depending on their long term outlook on interest rates.

If BoE interest rates go up in line with inflation, then it doens't matter so much. But the problem is that's not happening.

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The banks have a Three quarter % profit they make between the depositor and lender.

Inflation does not afect proffit only its purchasing power.

How ever

Banks have no one to borrow money to

So were is the money?

Share Market

Dirivites

Currency speculation

Yep the money is on the Horses

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If inflation is running at, say 4%, lending at a rate less than that is always a losing proposition. The bank would obviously raise interest rates and lower LTV and term to depending on their long term outlook on interest rates.

Could someone expand on this for a bear of little intelligence trying to get a handle on the variables?

You've got this wrong. The bank doesn't lose money, the depositor does. It's not the bank's money that's losing value. The bank can still make money if inflation is higher than the interest rate - it makes money on the difference between the rate that it pay the depositor and the rate that it charges the borrower.

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You've got this wrong. The bank doesn't lose money, the depositor does. It's not the bank's money that's losing value. The bank can still make money if inflation is higher than the interest rate - it makes money on the difference between the rate that it pay the depositor and the rate that it charges the borrower.

That assumes they lend the deposits to borrowers. instead of investing it on the stock market for a better return through their trading desks, as they did with their QE money. .

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You've got this wrong. The bank doesn't lose money, the depositor does. It's not the bank's money that's losing value. The bank can still make money if inflation is higher than the interest rate - it makes money on the difference between the rate that it pay the depositor and the rate that it charges the borrower.

banks sold their mortgages to each other....they did so at rates BETTER than Bond rates.....banks have already had to understate their losses on these things...CDOs, MBS etc etc.

so yes, in past theory depositors lose, but the modern shadow banking system has bought into this hook line and sinker and produced "clever" Financial assets. Much banking Credit has a source in these Financial assets, not depositors.

Witness that NR FAILED to get funding for its roll overs due to the lending market drying up...

If mortgages were making so much money, then there would be no need for bailout or QE or whatever else they do.

Not forgetting Defaults and all the rest....

Yes, savers lose out, but they are not the ones receiving "liquidity".

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You've got this wrong. The bank doesn't lose money, the depositor does. It's not the bank's money that's losing value. The bank can still make money if inflation is higher than the interest rate - it makes money on the difference between the rate that it pay the depositor and the rate that it charges the borrower.

This is wrong. the money belongs to the bank, not the depositor. The Depositor is just a creditor hoping to make a buck. As someone posted some while ago, the problem today is not the problem of return on capital, but the return OF capital.

See above re CDOs.

From a research Document ( read by the FED it appears)

Perhaps most importantly, we find that

inflation has a dramatic negative impact

on the profitability of banks. Various

measures of bank profitability—net

interest margins, net profits, rate of

return on equity, and value added by the

banking sector—all decline in real

terms as inflation rises, after controlling

for other variables. Figure 2 plots banks’

real net interest margins against the

inflation quartiles to give one example.

(The real net interest margin is a measure

of the inflation-adjusted spread

between a bank’s lending rate and its

cost of obtaining funds.) We see that

even at fairly modest inflation rates of

between 5.1 percent and 9.1 percent, the

real net interest margin turns negative.

Such low real rates of return suggest

that the incentives to expand bank operations

simply are not as strong as inflation

rises.

http://www.clevelandfed.org/research/commentary/2006/0515.pdf

Edited by Bloo Loo

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  • 150 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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