Federal interest-rate cuts good for businesses, borrowers but bad for banks

PROVIDENCE – The emergency half-percentage-point cut in the federal interest rate is bad news for banks, at least from a revenue perspective.

The Federal Reserve’s rate cut, which brings interest rates to between 1% and 1.25%, was announced last week amid growing fears over the new coronavirus disease, also known as COVID-19.

Banks across the country, including those in Rhode Island, will likely see their profits shrink, as the short-term interest rate for borrowers with variable rate loans, as well as the prime rate, drop. The long-term interest rate, measured in terms of the 10-year treasury bond, has also decreased due to rising demand for safer investment alternatives.

“All across the yield curve, the interest rate that borrowers will pay on loans will go down,” said Mark K. W. Gim, president and chief operating officer of The Washington Trust Co.

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The squeeze on banks comes after a challenging year in 2019, when three consecutive interest-rate cuts reduced the spread between the income generated from lending money and the expense of holding deposits, lowering bank profits.

Gim predicted the latest, more-dramatic cut would further reduce bank income, with ramifications through 2020 and possibly even 2021.

As for just how much banks, including Washington Trust, will lose as a result of the interest-rate cut remains unclear. Gim said more information would emerge as publicly traded financial institutions report their quarterly earnings at the end of the month.

He also noted that the negative impact might not be permanent; depending on what happens with coronavirus, the Federal Reserve might consider upping the rates again.

With that in mind, Gim did not expect the company’s strategy for the year to change, highlighting that its diverse lines of business can mitigate the harm caused by lower profits on loans versus deposits.

The residential mortgage business, which Gim rated as Washington Trust’s third-highest source of revenue, will likely see an uptick in activity as existing customers refinance their mortgages and new consumers take advantage of the low-interest environment.

Washington Trust has also seen an influx of questions from customers on its wealth-management side as markets dip amid global health concerns.

Gim advised investors to take a similar tack to the bank itself: Don’t react too rapidly and be careful about taking risks.

Nancy Lavin is a staff writer for the PBN. Contact her at lavin@pbn.com.