Impact Of Interest Hikes On The Banking Industry Assignment Sample

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Introduction to The Impact Of Interest Hikes On The Banking Industry Assignment

• Interest rate increases occur when central banks raise benchmark rates to control inflation or stabilise the financial scenario. These changes have significant implications for the banking sector. It influences lending, borrowing, and profitability (Adrian and Natalucci, 2022).
• This presentation critically examines the impact of interest rate hikes on bank performance, risk management strategies, and sources of funds.
• The analysis includes theories like the Interest Rate Parity Theory, Liquidity Preference Theory, and Asset-Liability Management Theory. With this, real-world examples in global banking provide practical understanding of the situation.
• The objective is to understand how banks deal with challenges and opportunities when the interest rate is increasing, ensuring sustainable financial operations.

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One of the most important financial tools that is used by central banks is interest rates. An increase in interest rate is done with the aim of reducing inflation by taking away from excessive borrowing and spending by consumers. However, this increase affects the banks in different ways. High interest rates increase the cost of funds especially from interbank lending and external borrowing. The banks also benefit from this improved interest margin as the loan interest rate increases as well. This presentation studies the different academic perspectives and industrial case studies on this topic. Various theories like the interest rate parity theory are used in this presentation to explain the movements of currency and the operations of the bank. The liquidity preference theory has been used to analyse the behaviour of the depositor and finally the asset liability management theory has been used to assess the risk management process. The main role of this presentation is to critically analyse the different ways in which banks adapt themselves during interest rate hikes.

Impact Of Interest Hikes On The Banking Industry Assignment Sample

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Industry Overview

• The banking industry plays a very important role in financial systems. They help with the credit flow and in managing financial risks. Central banks adjust the rate of interest to control inflation. This directly impacts banks' operations
• Interest rate increases can change bank profitability, lending capacity, and risk management strategies. Higher rates often cause increased rates for loan interest. This benefits the net interest margins (NIM). However, they also have challenges like higher risks and increased costs for funding (Beutler et al., 2020).
• Major banks such as JPMorgan Chase, HSBC, and Bank of America often make strategic adjustments in lending portfolios and management of liquidity. Understanding the effects of rate increases is important for understanding financial health and the strength of the banking sector

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Industries are a very important tool that central banks like the Federal Reserve for the European Central Bank use in order to control inflation and create stable economies. For banks these hikes in interest rates have both advantages and disadvantages. On one hand they need to increase income from loans on interests and on the other hand, the increased cost of funds reduces the total profit levels of the bank. Moreover, it has been seen that increasing the rate of interest can throw off customers from borrowing from banks. This leads to reduction in the growth of loans. The assets and liabilities of the bank should be managed carefully in order to overcome the negative effects of interest rate increases. Bank performance, risk management and sources of funds are impacted by interest rate hikes. These effects will be explained in this presentation with real world examples of major banks.

Theoretical framework

• The Interest rate Parity Theory shows the development of asset management in the financial business strategy (Aliber, 1973). It also determines the influence of banks on the global development of operations
• The collaboration between the demand for asset development and interest rates has been included in the Liquidity Preference Theory (Seth, 2014). The strategic management of business has been analysed in this theory
• On the other hand, the liability of assets can be managed through Asset Liablty Management theory (Bhatt, 2020). The profitability of business can be addressed through this theory

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The theoretical analysis of the profit management in banking sector has been included in this presentation to show the importance of interest rates for the business economy. It has been perceived that the financial asset management and liquidity of risks can be improved through the strategic enhancement of business. The banking sector has to be developed with innovative strategies and management of assets to improve the economic condition of the countries. In this context the financial investment has to be developed to improve the economic market of the countries especially in the post-pandemic period. These three theories discussed above are useful for the analysis of relationship of interest rate with the banking profitability development and adhering the challenges.

Impact on bank performance

• Interest rate increases influence the financial performance of a bank. One such effect is on Net Interest Margins (NIM). NIM is the difference between interest earned on loans and interest paid on deposits.
• Higher rates lead to increased NIMs which benefits the banks’ profitability. However, rising rates may also decrease the demand for loans and increase borrower defaults. This has an impact on the overall revenue. Additionally, banks with significant fixed-rate loan portfolios can face losses.
• Institutions with strong Asset-Liability Management (ALM) strategies often perform well in such environments (Bhatt, 2020). Case studies of banks like JPMorgan Chase and HSBC show how proper rate management can lead to profit retention.

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Increases in the interest rate has a positive effect on the net interest margin as banks are able to earn more loans than they pay for deposits. However, these high rates can also reduce the demand for loans and increase the risk of credit. Banks that have a large fixed rate loan portfolio can experience a decrease in profitability. In order to overcome these risk banks, adopt the asset liability management strategy. For example, JP Morgan Chase and HSBC apply interest rate management to maintain profitability.

Risk management

Interest rate hikes introduce various risks for banks, which are mentioned below:

• Interest Rate Risk: Fixed-rate loan portfolios become less profitable as rates increase. Banks overcome this through hedging and swaps.
• Credit Risk: Borrowers face higher repayment problems, increasing rates of people who cannot make payments. Credit scoring models and loan diversification help reduce this risk (Girnara, 2020).
• Liquidity Risk: Higher rates can lead to rapid withdrawals of deposit by bankers. Banks maintain liquidity buffers and access to interbank funding.

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Using the Asset-Liability Management (ALM) Theory, banks apply stress testing and scenario analysis to predict and manage any risks. Risk management committees play a critical role in getting financial stability during interest rate fluctuations.

The increasing rate of interest exposes banks to risks as fixed rate loans are less profitable. In order to overcome this challenge interest rate swaps are used by banks. Credit risk also increases as borrowers have to pay a higher cost for repayment. In order to manage these banks, tighten the credit standards and apply testing by the application of stress. Many depositors withdraw funds for getting higher returns and therefore liquidity risk can arise. Through asset liability management, banks monitor all different scenarios and adjust their portfolio accordingly.

Impact on sources of funds

Interest rate hikes have a big impact on a bank's source of funds. These effects are discussed below.

• Deposits: Banks may raise interest rates on deposits to attract customers. This increases the funding costs.
• Interbank Borrowing: Increasing rates make short-term borrowing from other banks more expensive.
• Capital Markets: Banks can issue bonds or securities at higher values, leading to increased interest related spending.
• Central Bank Funding: In times of liquidity stress, banks may take central bank loans, often at very high rates (India Today, 2023).

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Effective management of these funding sources is very important. The Liquidity Preference Theory suggests that as rates increase, depositors prefer to save. This provides the banks with greater funding. However, maintaining a balance between deposits, borrowing, and capital market funding remains important as well.

The funding sources of the bank are also impacted by increases in interest rates. Deposits are more expensive as the interest rates are increased to keep customers. Interbank borrowing also becomes more expensive. This has a negative impact on short term liquidity. Security demands or bonds are issued at higher profit. Central banks can provide funding but not yet at low cost. The liquidity preference theory says higher rates encourage saving and deposits are increased. However, the funding of the bank must be balanced carefully to maintain profitability and liquidity.

Impact on lending and investment portfolio

• The higher interest rates give opportunity to the banks to make more money by making investments and earning profits (Akomea-Frimpong et al. 2022)
• Lending out money at short-term interest can be profitable for the banks with the increase of interest rates. The bank system can be motivated and the flow of money operation can be increased
• Rising interest rates makes all debt more expensive and creates higher income for savers. Moreover, stocks, bonds may decrease with the higher interest of banks

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The higher interest rates of banking deposits affect the earning of the banks effectively. The organisations can gain more profit through the increase of investment or deposit in the bank with the height of interest rates. On the other hand, higher interest rates are usually a sign of a booming economy. The profit of the banks depends on the difference between the interest they pay to their customers and the yield they make through investing. Higher interest rates increase the yield in investing. The central banks like the Bank of England (BoE) keep the interest rate as a tool to control unemployment and inflation rates. The higher interest rates make people encouraged to cut and save their costs. Central banks cut rates to slow down the activities of the economy by making borrowing more expensive. In the COVID-19 pandemic period the supply chain disruption and higher inflation had led to the decrease of economic earring of the banks which has transformed gradually with the lowering of rate of inflation and developing banking interests.

Case study analysis

• The case study of the Bank of England (BOE) shows the impact of higher interest rate on improving banking stability in the financial portfolio
• According to BOE data the higher interest rates has impacted in the household, net earnings and building societies £4.6bn in 2024 (Bankofengland.co.uk, 2025)
• The Bank of England Monetary Policy Committee (MPC) is responsible for setting the base interest rates. It aims to keep the inflation stable to 2% for maintaining the financial stability
• The current status of interest rate of BOE includes 4.5% in 2025 which has been taken by MPC to adopt a wait-and-see approach to combat the rising inflation (Bankofengland.co.uk, 2025)

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The rising inflation of the pandemic period has been indicated as the tool of managing the interest rates of the banking sector. In the UK, the economy of the country is dependent on the financial performance of the banks, the asset management and number of transactions. The economy and global development of the country can be conducted through the increase of the rate of interest of banks. BOE has made its interest rate to 4.5% to assess the market situation of the country, monitor the British economy and the unease of customers in deposits and investment. The higher interest rates of banks controlled the inflation rates in the UK in the post-pandemic period to improve strategic development of asset management.

Recommendations

• It can be recommended that the development of financial stability in the banking sector can be brought through managing strategy-making effectively
• The risks of investment or borrowing can be reduced through reducing the risk of financial stability, monitoring as a result of transition to higher interest rates (AboElsoud et al. 2021)
• The challenges faced by bonds, shares and the real estate businesses due to higher interest rate can be reduced through the bridging the gap of liquidity of asset rates and interest paid to the customers (Akomea-Frimpong et al. 2022)
• BOE also can use the strategic implementation of financial policies to control the risks leveraged from higher interest rates

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The financial turbulence can be controlled through the development of adequate strategies in the banking sector. The management of risks in the banking sector due to higher interest rates can be pacified through the changing of banking rules. For example, the volatility of the economic market in the pandemic period has been witnessed in 2020-21 in the UK which impacted on banking profitability portfolio and investment. In this context, it can be recommended that BOE can improve the asset liability management for handling the risks related to investment consideration in the bank. On the other hand, the rate of interest will have to be controlled by the central banks to manage inflation effectively. The improvement of banking strategy management and cost of funding analysis can be used by the banks in the financial industry to recover the challenges.

Conclusion

• Higher interest rates in the banking industry can improve the profitability management and investment portfolio
• Rising interest controls inflation in the economic market and make the business stable
• The earning of profit share is improved for the banks with the increase of rate of interest through volume increase of amount of deposits and assets
• Challenges of risk management can be conducted by the banks through controlling the asset regulation policies

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In this presentation it has been depicted that the increase of rate of interest in banks can become profitable for the organisations and the economy. It has been discussed in this study that increase of interest rates impacts on banking performance according to the demand of loans and borrowing. On the other hand, higher interest rates can reduce the demand of loans and develop the risk of credit. The case study of Bank of England (BOE) has been included in this analysis to show the increase of interest rates often creates challenges for the banks in managing the assets and the profitability portfolio. Recommendations have been suggested for the banks to improve the strategic financial scenario for adapting the short-term borrowing process as profitable for earning profits.

References

• AboElsoud, M.E., AlQudah, A. and Paparas, D., 2021. Effectiveness of interest rate policy on the management of macroeconomic stability: Evidence from the United Kingdom. Journal of Organisational Studies and Innovation, 7(4), pp.35-50.
• Adrian, T. and Natalucci, F. (2022). Central Banks Hike Interest Rates in Sync to Tame Inflation Pressures. [online] IMF. Available at: https://www.imf.org/en/Blogs/Articles/2022/08/10/central-banks-hike-interest-rates-in-sync-to-tame-inflation-pressures.
• Akomea-Frimpong, I., Adeabah, D., Ofosu, D. and Tenakwah, E.J., 2022. A review of studies on green finance of banks, research gaps and future directions. Journal of Sustainable Finance & Investment, 12(4), pp.1241-1264.
• Akomea-Frimpong, I., Adeabah, D., Ofosu, D. and Tenakwah, E.J., 2022. A review of studies on green finance of banks, research gaps and future directions. Journal of Sustainable Finance & Investment, 12(4), pp.1241-1264.
• Aliber, R.Z. (1973). The Interest Rate Parity Theorem: A Reinterpretation. Journal of Political Economy, [online] 81(6), p.1451. doi:https://doi.org/10.1086/260137.
• Bankofengland.co.uk, 2025. banking interest. available at: https://www.bankofengland.co.uk/explainers/current-interest-rate [Accessed on: 26^th Mar c=2025]
• Beutler, T., Bichsel, R., Bruhin, A. and Danton, J. (2020). The Impact of Interest Rate Risk on Bank Lending. Journal of Banking & Finance, 115, p.105797. doi:https://doi.org/10.1016/j.jbankfin.2020.105797.
• Bhat, D.A. (2020). A review of asset liability management models. [online] Academia.edu. Available at: https://www.academia.edu/107426070/A_review_of_asset_liability_management_models [Accessed 26 Mar. 2025].
• Girnara, M. (2020). ‘IMPACT OF CHANGE IN INTEREST RATES ON PROFITABILITY OF BANKING SECTOR IN INDIA’. National Level Conclave - 2017. [online] Available at: https://www.researchgate.net/publication/347516076_%27IMPACT_OF_CHANGE_IN_INTEREST_RATES_ON_PROFITABILITY_OF_BANKING_SECTOR_IN_INDIA%27.
• India Today. (2023). Explained: How interest rate hikes impact banks. [online] India Today. Available at: https://www.indiatoday.in/business/story/interest-rate-hikes-global-banking-crisis-explained-2350766-2023-03-24 [Accessed 26 Mar. 2025].
• Seth, T. (2014). Liquidity Preference Theory: Motives and Criticism (With Diagram). [online] Economics Discussion. Available at: https://www.economicsdiscussion.net/theories/liquidity-preference-theory-motives-and-criticism-with-diagram/1805.