Why are some banks at risk for having large portfolios of low interest rate mortgages?
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Banks hold onto people’s money, called a deposit, and generally give them some interest in return. The way the bank can afford to pay them interest is the bank uses their money to give out to other people as a loan, and charge them a higher interest than what they pay for deposits.
The bank runs off of the difference in the interest rates – they charge some interest, use that to pay their costs (including the costs when people they loaned money can’t pay back), and give less out to depositors.
In theory a depositor can take back all their money at any time. This isn’t a problem as long as there’s enough other depositors who don’t to make up for it, but a necessary part of a bank’s business is that they use deposits to give out as loans, and so if everyone withdraws they won’t have enough money to pay out to everyone. This can cause a problem called a bank run, and is really bad. Thankfully the FDIC helps make sure customers get their money, but the bank can collapse and go out of business if it happens.
The problem with having too many low interest loans is two-fold: one, the bank isn’t making much money off of those loans, and it’s harder to run their business. Two, other banks that have better loans can entice customers to give them money with higher interest rates.
The banks with a portfolio of low interest rate mortgages may not be able to compete with those other banks paying more, and if enough people leave to earn more interest on their savings it’s possible the bank may not have enough money from other deposits that stayed to pay everyone leaving, and if it can’t raise money through other ways could collapse.
Decades of Low interest rates combined with record high housing costs and deregulation have lead to banks selling mortgages to a lot of families that honestly should never have qualified for a mortgage in the first place.
Those types of loans are higher risk and don’t pay off that well, so banks do whatever they can to either get rid of them as bonds, or take risks in other areas to make more money.
People who are not financially savvy get mortgages with payments that are near the limit of what the can afford per month.
As interest rates and cost of living increases, people are at higher risk of default (not being able to pay their mortgages).
If this happens en-mass (like it did in 2009) then those banks could fail.
Banks hold onto people’s money, called a deposit, and generally give them some interest in return. The way the bank can afford to pay them interest is the bank uses their money to give out to other people as a loan, and charge them a higher interest than what they pay for deposits.
The bank runs off of the difference in the interest rates – they charge some interest, use that to pay their costs (including the costs when people they loaned money can’t pay back), and give less out to depositors.
In theory a depositor can take back all their money at any time. This isn’t a problem as long as there’s enough other depositors who don’t to make up for it, but a necessary part of a bank’s business is that they use deposits to give out as loans, and so if everyone withdraws they won’t have enough money to pay out to everyone. This can cause a problem called a bank run, and is really bad. Thankfully the FDIC helps make sure customers get their money, but the bank can collapse and go out of business if it happens.
The problem with having too many low interest loans is two-fold: one, the bank isn’t making much money off of those loans, and it’s harder to run their business. Two, other banks that have better loans can entice customers to give them money with higher interest rates.
The banks with a portfolio of low interest rate mortgages may not be able to compete with those other banks paying more, and if enough people leave to earn more interest on their savings it’s possible the bank may not have enough money from other deposits that stayed to pay everyone leaving, and if it can’t raise money through other ways could collapse.
Decades of Low interest rates combined with record high housing costs and deregulation have lead to banks selling mortgages to a lot of families that honestly should never have qualified for a mortgage in the first place.
Those types of loans are higher risk and don’t pay off that well, so banks do whatever they can to either get rid of them as bonds, or take risks in other areas to make more money.
People who are not financially savvy get mortgages with payments that are near the limit of what the can afford per month.
As interest rates and cost of living increases, people are at higher risk of default (not being able to pay their mortgages).
If this happens en-mass (like it did in 2009) then those banks could fail.
Most banks sell loans to someone else so they can make more loans. As a bank there’s a limit to how much money you can loan based on how much money is deposited. Low interest loans aren’t attractive for investors to buy, because they can get a better return on higher interest loans for the same price. Banks are then stuck having to sell the loans at a discount which loses them money, or keep the loans and not be able to make as many new loans.
All those comments re margins and deposit liquidity are true but there are protections against that for a prudent bank that hedges their portfolio properly and uses sufficient levels of wholesale funding to offset the depositor flight risk. However,this is more expensive than using retail deposits when rates are low and so some lenders choose not to buy them. That is when the risk crystallises as an issue when depositors take flight.
Source: award winning U.K. mortgage head for c. 30 years and member of Council Of Mortgage Lenders Executive Committee for ten years. Now the day job is getting these lenders out of the shit I warned them about.
Edit: clarity.
All those comments re margins and deposit liquidity are true but there are protections against that for a prudent bank that hedges their portfolio properly and uses sufficient levels of wholesale funding to offset the depositor flight risk. However,this is more expensive than using retail deposits when rates are low and so some lenders choose not to buy them. That is when the risk crystallises as an issue when depositors take flight.
Source: award winning U.K. mortgage head for c. 30 years and member of Council Of Mortgage Lenders Executive Committee for ten years. Now the day job is getting these lenders out of the shit I warned them about.
Edit: clarity.
Most banks sell loans to someone else so they can make more loans. As a bank there’s a limit to how much money you can loan based on how much money is deposited. Low interest loans aren’t attractive for investors to buy, because they can get a better return on higher interest loans for the same price. Banks are then stuck having to sell the loans at a discount which loses them money, or keep the loans and not be able to make as many new loans.
Low interest mortgages don’t make as much money as high interest mortgages, but the liabilities (the deposits) are the same. Hence buyers don’t want to buy something they could do themselves but more profitably.
Low interest mortgages don’t make as much money as high interest mortgages, but the liabilities (the deposits) are the same. Hence buyers don’t want to buy something they could do themselves but more profitably.
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