While resentment among savers is growing over the low interest rate on the savings book, banks are publishing mega profits thanks to the high interest rate. What’s going on?
KBC made a profit of 882 million euros in the first three months of 2023, the bank-insurer communicated this week. This is almost twice as much as in the first quarter of last year, when a profit of 452 million euros was recorded. KBC is not the only bank making huge profits these days. France’S BNP Paribas, the largest bank in the eurozone, made a net profit of 4.4 billion euros in the first three months of this year. Deutsche Bank, Germany’s largest banking group, recorded a net profit of 1.3 billion euros over the same period, the best quarterly figure in ten years. ING, the largest Dutch bank, made a profit of 1.6 billion euros, three times as much as a year earlier. Those are numbers to be giddy about. All banks are heading for a record year.
Why is it that banks can present such phenomenal profit figures? Each bank has a specific story. For example, KBC had a windfall of 372 million euros thanks to the completion of the Irish activities. And last year, KBC created a buffer to absorb the shock of the war in Ukraine, but it turned out to be less bad than feared, so that 26 million euros in facilities were already taken back. But there is a much more important reason why the profits of all banks have increased so spectacularly: the rising interest rates.
Free money trap
After the financial and economic crisis of 2008, the European Central Bank (ECB) reduced the interest rate from 4 percent to 1 percent in one year. Then she even lowered the interest rate to zero percent. That means that money became virtually free: you could borrow at a historically low interest rate of 1 percent. The flip side of the coin was that you also received hardly any interest on your savings book, namely 0.11 percent.
The reasoning behind the fall in interest rates was simple: the ECB wanted to boost the economy, on the one hand by making consumption and investment more interesting with cheaper loans and, on the other hand, by making savings less attractive with the lower interest rates on savings books. In this way, the economy was, as it were, doped: the economy was doing particularly well because the ECB kept interest rates so low for almost 15 years.
At the end of 2020, everything tilted: prices began to climb sharply. Inflation rose, as a result of the ‘free money’ policy, but also due to the rapid economic recovery after the corona crisis and then due to the war in Ukraine that raised energy prices to unprecedented heights. Inflation peaked above 10 percent last year. And that’s while economists always say that an inflation rate of 2 percent is ideal. To curb that far too high inflation, the ECB did the reverse move of what it had done in 2008: the ECB has been gradually raising interest rates to 3.75 percent since September 2022. The banks are now benefiting from this.
Where do banks make money in the first place? Their main source of income is what economists call the interest margin: the difference between the credit rate (the interest you receive on a savings account, for example) and the debit rate (the interest you pay on a loan).
The profits of the central banks would be better used to invest in the economy, rather than to speculate the profits of the commercial banks.
A number example makes it clear right away. A year ago you could borrow at 1 percent and you got 0.11 percent on your savings book. Interest margin for the bank: 0.89 percent. Today, the interest on a loan is at 4 percent, and the interest on your savings book is 0.6 percent. Interest margin for the bank: 3.4 percent. The interest rate margin for the bank is almost four times as high as a year ago.
Many savers today move their money from the savings book to a term account, where their money is fixed for a certain period of time, but where they can catch around 2 percent interest. That is also interesting for the bank, because the interest margin is then 2 percent, more than double compared to a year ago. Thus, the banks get much more income from the difference between what they have to pay in interest on your savings and what they receive in interest on loans.