How Banks Make Money
Banks make money on the spread between what they pay depositors and what they charge borrowers. This spread is called the net interest margin (NIM).
- Bank pays you 0.5% on your savings account
- Bank charges a homebuyer 7% on their mortgage
- The bank keeps the ~6.5% spread
This is why interest rates matter so much to bank stocks. Higher rates generally mean wider spreads — more profit.
The Yield Curve: The Single Most Important Indicator
The yield curve plots interest rates across different maturities (2-year, 10-year, 30-year Treasury bonds).
Normal yield curve (upward sloping): Long-term rates higher than short-term. Banks borrow short (deposits, which pay low rates) and lend long (mortgages, which charge high rates). Wide spread = big profits. Bank stocks rally.
Inverted yield curve (downward sloping): Short-term rates higher than long-term. Banks' borrowing costs approach or exceed their lending income. Narrow spread = squeezed profits. Bank stocks struggle.
Steepening yield curve: The spread is widening. Banks love this — it means their profit margins are expanding. Bank stocks tend to outperform.
Flattening yield curve: The spread is narrowing. Banks' margins are compressing. Bank stocks tend to underperform.
What Fed Actions Mean for Banks
- **Rate hikes:** Generally positive for banks (higher rates = wider margins), BUT only if the yield curve doesn't invert
- **Rate cuts:** Generally negative short-term (margins compress), but positive if it prevents a recession
- **Quantitative easing:** Mixed — supports asset prices but can flatten the curve
Beyond Rates: Credit Quality
The other major driver of bank stocks is credit quality — are borrowers paying back their loans?
- Rising unemployment → more loan defaults → bank stocks fall
- Strong economy → healthy credit → bank stocks rise
- Commercial real estate stress → bank exposure concerns → bank stocks fall
When both the yield curve is steepening AND the economy is healthy, bank stocks tend to be among the best performers in the market.
For informational purposes only — not financial advice.