The following is an excerpt from the Federal Reserve website, released September
ID: 2801197 • Letter: T
Question
The following is an excerpt from the Federal Reserve website, released September 21, 2016: “..........the Committee decided to maintain the target range for the federal funds rate at 14 to 12 percent. The Committee judges that a case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives”. Explain what would be the immediate effect on a bank income if its gap analysis yields a GAP = - $500 million? What would happen to the bank income if the increase in the federal funds rate finally materializes?
Explanation / Answer
FEDERAL FUND RATE AND BANK INCOME
THE BANKING SECTOR'S PROFITABILITY INCREASES WITH INTEREST RATE HIKES. INSTITUTIONS IN THE BANKING SECTOR LIKE RETAIL BANKS , COMMERCIAL BANKS, INVESTMENT BANKS ETC HAVE MASSIVE CASH HOLDINGS DUE TO CUSTOMER BALANCES AND BSINESS ACTIVITIES.
INCREASES IN FEDERAL FUND RATES DIRECTLY INCREASES THE YIELD ON THIS CASH AND PROCEEDS GO DIRECTLY TO EARNINGS. A SIMILAR ANALOGOUS SITUATION IS WHEN THE PRICE OF OIL RISES FOR OIL DRILLERS. THE BENEFITS OF HIGHER INTEREST RATES IS MOST NOTABLE FOR BROKERAGES, COMMERCIAL BANKS AND REGIONAL BANKS
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