With the U.S. Federal Reserve Board widely expected to begin cutting interest rates this week, the onset of looser monetary policy will initially be negative for the banking sector, says Moody’s Ratings in a new report.
The rating agency said the Fed is likely to cut the federal funds rate by 25 basis points on Sept. 18, beginning an easing cycle that’s expected to result in a cumulative 200 basis points in rate cuts by the end of 2025.
“Initially, the rate cuts will be credit negative for most U.S. banks,” Moody’s said. “We expect their deposit costs to reprice downward more slowly than their loan yields, constraining net interest income, which is most banks’ largest revenue source.”
Eventually, deposit costs will catch up with loan rates, which will bolster net interest income, it said.
In the meantime, the rate cuts will be positive for banks’ asset quality, Moody’s said, “because lower rates make debt payments more affordable for borrowers with floating-rate loans. And borrowers with maturing loans that need to refinance may be able to do so at lower interest rates.”
“Additionally, if lower rates prolong economic growth, it will help banks maintain and improve their asset quality,” it said.
In the short run, however, there’s no material effect on asset risk, it said.
“Cumulatively, as rate cuts become more impactful, that will support commercial real estate loan refinancing, a challenged asset class for many regional banks,” Moody’s said.
While lower rates will initially weigh on banks’ net interest income, they will also boost fee-generating opportunities from higher mortgage originations and capital markets volumes, it said.
Moody’s said it doesn’t expect the initial rate cuts to impact the banks’ funding and liquidity positions this year, “but in 2025 the cumulative effect of rate cuts will reduce depositors’ incentive to seek higher yields.”
The banking sector should also see further consolidation in a declining rate environment, as lower rates help reduce a key obstacle to merger-and-acquisition activity, Moody’s noted.
“As medium- and longer-term interest rates decline and securities mature, unrealized losses will also decline more, reducing the fair value accounting marks that make it more difficult for buyers and sellers to agree on a price,” it said.