How rising interest rates impact finance stocks
In the finance sector, changes in interest rates affect everything from consumer loans to corporate borrowing decisions. When central banks increase rates, it initiates a chain reaction throughout the financial industry.
Some companies experience margin expansion, while others face profitability and growth pressure. In this article, we will explore how rising interest rates impact financial stocks.
Increase in Net Interest Margins (NIMs)
Banks usually benefit in the early stages of rising rates as the yield on new and floating-rate loans rises more rapidly than the cost of deposits. This widens their Net Interest Margins (NIMs), which allows them to make more money on the spread between what they lend and what they pay depositors. During such periods, banks that have a strong CASA base tend to outperform, as they do not have to rely on high-cost deposits.
However, this advantage does not last forever because eventually, deposit rates also increase, which squeezes their margins. Still, the initial increase in profitability is often reflected in positive quarterly earnings and the performance of finance stocks.
Higher funding costs for NBFCs and fintech lenders
NBFCs and fintech lending companies are on the opposite end of the impact of rising interest rates. Their borrowing costs increase instantaneously because they are dependent upon market-based instruments such as bonds, commercial papers, and bank loans. As funding gets more costly, their lending margins become smaller, unless they charge customers higher rates, which is not always possible in a competitive market.
This can slow down the growth of loans and make it more difficult for them to remain profitable. During tightening phases, investors are often wary of emerging or leveraged lenders, which is why sentiment-driven movements like these can have a significant impact on Jio financial share price or any other stocks in the sector.
Slowdown in credit demand
When interest rates are high, it is more expensive for households and businesses to borrow money. Consumers may delay home purchases, car loans, or personal loans, while companies may delay expansion plans due to higher capital costs. This leads to slower credit demands in the retail and corporate segments.
As loan disbursals weaken, lenders have a moderation in growth despite temporarily stronger margins. Sectors such as mortgages and small and medium enterprise lending are usually most sensitive to increases in interest rates, and the combined slowdown is often mirrored in their earnings reports.
Impact on asset quality and NPAs
Higher interest rates raise the cost of debt repayment, especially for those borrowers who have floating-rate debt. As the cost of repaying existing loans increases, financially stressed customers find it difficult to afford the EMI, and it can lead to a rise in delinquencies. This, therefore, affects asset quality and can further result in increased NPAs for the lenders, particularly those who have hefty exposure to the riskier segments.
In this financial condition, banks with strong underwriting practices and buffers in these provisions are better placed to absorb these pressures, while aggressive lenders may see a deterioration in their balance sheet.
Impact on valuations and investor sentiment
Interest rate increases can also drive investor valuations of finance stocks. Higher bond yields increase the attractiveness of fixed-income instruments, which can lead to some investors reducing their exposure to equities and shifting it to fixed-income instruments.
On the other hand, during periods of turmoil, large and stable financial institutions will often be favoured by investors due to a stronger underlying financial position. Hence, interest rate changes matter for investors who are willing to make a long-term investment in a specific financial stock.
Valuable insights and long-term investment opportunities
Increasing interest rates have both positive and negative effects on financial stocks. Therefore, for investors, rather than considering rate increases as positive or negative, the best way to identify quality finance stocks is to analyse the resilience of each company along with strategic positioning in the finance sector. If approached correctly, increasing interest rates can give valuable insights and long-term investment opportunities to investors in the financial sector.
