Banking - Interest rates - Essay Example

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Benefits and costs of low Japanese interest rates for the banking industry Interest rate is one of the major factors affecting economies productivity. It also has direct effects on inflation rates and is one of the monetary policies that governments use to ensure stability of their economies…
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Banking - Interest rates
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"Banking - Interest rates"

One of the effects of the low interest rate on the Japanese banking sector is reduced productivity. Banks have been forced to operate under low revenue level and net interest margins explain this. Interests that banks charge on their customers on loans forms a significant percentage of their income, while interest that banks pay on their customers’ deposits contribute to the banks’ expenditure. Maximizing revenues would therefore require optimizing the gap between interest charged on loans and interest paid on deposit. The country’s low interest rate however offers a restricted interest rate margin by putting an upper limit on what the banks can charge. At the same time, competition in the industry dictates minimum limits that banks can offer on deposits and the two factors means high expenditures on interest on deposits and limited revenues from interest on loans to customers. This has reduced profitability from lending and has forced some banks in Japan to seek alternative sources of revenues, apart from domestic lending (Weistroffer 2). Reports by the International Monetary Fund support the position that low interest rates have reduced profitability in the Japanese banking sector. According to the organization, the net interest margin has been declining and this has forced Japanese banks to venture into foreign markets. The low interest rate has also been associated with poor lending rates and this could be due to the banks’ change in interest from lending to other investment activities. Another cost of low interest rates, according to the International Monetary Fund, is the reduced capital accumulation potential of banks and this increase the banks’ susceptibility to loses. This means a significant level of instability that could be increasing and threaten the country’s banking sector (International Monetary Fund 9). The low interest rates also affect banks through other industries. Its effects of reduced net interest margin means that higher lending rates is a remedy for increasing revenues from lending and this may mean risky lending to other sectors of the economy. Consequences of such lending such as the recent housing bubble then affect the banking sector as value of property declines. Investors in the industries then default on their loans and the banks are not able to recover their money, even from sale of securities because of devaluation. This contributes to net capital accumulation and therefore increases the risk of instability of the banking sector. Effects of low interest rates on demand for loans also promotes borrowing that savings and is likely to increase the country’s inflation rate, a condition that affects all sectors in an economy, including the banking sector (Kliesen 1). Empirical studies on effects of low interest rates and shows that the rates benefits borrowers but disadvantage depositors. This means that customers would be motivated to take loans from banks and not to deposit with banks. Banks in such regulated economies therefore have limited investment opportunity because of limited reserves. Assumption of future stability would mean that banks might not be able to operate profitable because their major activities generate limited profit levels (Parck and Pennacchi 16- 18). The low interest rate also has benefits to the Japanese banking sector. As it suppressed the banks’ revenues from lending and deposits’ interest, the low rates motivated the Japanese banks to diversify into other investmen Read More
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