Financial challenges affecting depository institutions

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Financialchallenges affecting depository institutions

Interestrates in the financial markets have been low since the financialcrisis that occurred in 2007-2008. One of the key factors that havecontributed to a decline in the rate of interest is a significantdecline in lucrative investment opportunities, which have in turnreduced demand for loans (King 1). Consequently, the funds depositedin the depository institutions are exceeding the amounts that theseinstitutions are able to lend out in order to make revenue out ofdeposits. Therefore, the loan-to-deposit ratio has reducedsignificantly. This paper will address the challenges that depositoryinstitutions are going through as a result of low interest ratesmodern financial market and discuss how two depository institutions(including State Street Corp and Nomura Bank) are arresting thesituations.

Challenges

Thelow interest rates have different effects on depository institutions,but two of these effects are more common. First, the first effect issqueezing of margins, which can be attributed to a scenario in whichbanks are forced by circumstances to charge borrowers low interestrates while they fail to reduce the cost of deposits to below zero(King 2). This has reduced the financial performance of depositoryinstitutions.

Secondly,low interest rates have frustrated the normal borrowing-lending modelthat is used by depository institutions. Under the normalcircumstances, these institutions make short-term borrowings (or lendfrom short-term deposits) and lend in long-term (Bernanke 2). Withthe current decrease in returns made from long-term lending,depository institutions are almost failing to cover up the cost ofshort-term borrowing with low income that they generate from theirlong-term lending transactions.

Examplesof measures taken by depository institutions

Differentdepository institutions have taken different measures to contain theissue of a decline in revenue as a result of a serious decrease inthe rate of interest. These measures range from conservative toliberal ones. For example, State Street Corp., which a Boston BasedBank has adopted a conservative approach that involve charging aninterest on large deposits (Chung 1). This is a measure that isintended to reduce deposits in order to correct thelending-to-deposits ratio, while still helping the institution makesome returns from large deposits. So far, this measure has helped thebank reduce deposits by $ 150 billion, which confirms that themeasure is quite effective in spite of the fact that it increases therisk of losing some customers (Chung 1).

Otherbanks have opted for more liberal measures, such as diversificationof services and expansion of the profit making divisions. Forexample, Nomura Bank U.S. segment decided to bulk its wealthmanagement and capital management divisions, instead of relying onrevenue earned from loans (Rudegeair 1). With the wealth managementdivision, the bank is able to collect a commission or fees byproviding advisory services to wealthy people and use its capitaldivision to help large companies sell their stock. These arealternative methods of helping the bank make revenue and withstandthe financial shocks prevailing on the market.

Conclusion

Apersistent decrease in the rate of interest has affected manydepository institutions. This is because these institutions have lostthe capacity to make sufficient revenue from the amount that theylend to clients in order to cover the costs they incur from theirshort-term borrowings as well as short-term deposits. Some banks aretrying to arrest this situation by reducing their deposit taking andfocusing more on other profit making divisions in order to increasethe revenue generating capacities.

Workscited

Bernanke,S. Why are interest rates so low? Brookings.30 March. 2015. Web. 23 October 2015.

Chung,J. and Krouse, S. Big banks to America’s firms: We don’t wantyour cash. TheWall Street Journal.18 October. 2015. Web. 23 October 2015.

King,R. Why is the loan-to-deposit ratio declining for U.S. banks? MarketRealist Inc.31 March. 2015. Web. 23 October 2015.

Rudegeair,P. Regional banks sweat through low-rate torture. WallStreet Journal.21 April. 2015. Web. 23 October 2015.