Various commercial banks have all announced within the last two months that they will be increasing the interest rates on new and existing products, which will hit individuals and businesses in the pocket. But how will this affect the profitability of banks and how much they earn on their loans?

An interest rate is the rate paid in a period on an amount borrowed or deposited expressed as a percentage in proportion to the principal lent or deposited. Thus, if you borrow $100 from a commercial bank and it charges an effective annual rate of eight per cent, you are supposed to pay $8 in interest annually based on the duration of the loan. If you deposit $100 and the bank has a one per cent rate on deposits, you should get paid $1 over the year.

When interest rates decline in the market, it makes it cheaper to borrow money for spending on things like cars, homes, vacations, and other uses as determined by the borrower. When interest rates rise, borrowing gets more expensive.

In response to rising inflation, the Bank of Jamaica (BOJ) has increased its policy rate from 0.50 per cent in August to five per cent this month. This has impacted the cost of funding for various participants in the capital markets and impacted the cost of funding for all regulated financial institutions. One such example is the 180-day Treasury bill yield, rising from 1.20 per cent in July to 8.25 per cent as of this month. This has resulted in variable rate loans and debt rising by as much as 705 basis points (7.05 per cent) which means financing costs for businesses and consumers have risen without them taking on additional debt. There are eight commercial banks in Jamaica.

Commercial banks fund most of their lending through customer deposits with repurchase agreements, securitisation agreements, preference shares, and other borrowings making up other forms of funding. There was $1.46 trillion in deposits and $1.04 trillion in loans and advances at the end of March, with 39.6 per cent of those deposits held in foreign currency at the end of December. The weighted average effective rate of Jamaican-dollar loans in 2021 was 9.11 per cent with average deposit rates being below two per cent.

NCB Jamaica (NCBJ) had the highest effective rate of 11.13 per cent and earned $44.82 billion in interest income in 2021. Of that amount $36.05 billion was attributed to loans and advances, which stood at $392.49 billion. After paying $10.19 billion in interest expense, with $2.68 billion solely on $460.87 billion worth of customer deposits, NCBJ had net interest income of $34.63 billion, which translates to a net interest margin of 77 per cent. Only its competitor The Bank of Nova Scotia (Jamaica) Limited had a higher net interest margin of 97 per cent with a 9.37 per cent effective interest rate against the $193.26 billion worth of loans.

When NCBJ’s sensitivity analysis was checked in its audited financials, it revealed that its profit would have risen by $55.70 million had interest rates risen by 100 basis points (one per cent). However, its assets measured at fair value through other comprehensive income (FVOCI) would have seen a mark down with the line item declining by $6.60 billion. If interest rates declined by the same amount, profits would drop by $55.70 million, while FVOCI would rise by $7.44 billion. Not all commercial banks analysed had positive movement on profit due to higher interest rates.

This scenario has started to play out for its parent NCB Financial Group Limited, which had $17.11 billion in unrealised losses on those FVOCI instruments during its second quarter. Most of these losses stem from the bond portfolio and debt instruments which suffer when interest rates rise. Sagicor Group Jamaica and GraceKennedy saw unrealised losses of $6.18 billion and $290.81 million, respectively, during their first quarter.

While customer deposit rates haven’t marginally moved, the other sources of funding for banks have risen at a rapid pace. As such, NCBJ announced that it would be increasing the rates on existing facilities this month. Though CEO Septimus Blake noted that it would be a net positive for the bank, he was cautiously optimistic about giving any positive indications on such actions. NCBJ wrote off a record $3.66 billion in loans in 2021. Rising interest rates coupled with elevated inflation can push the non-performing loans of commercial banks higher, especially when they are trying to recover from reduced business over the last two years. Commercial banks wrote off a historic number of loans in 2021.

Sagicor Bank Jamaica (SBJ) announced that it would increase the interest rate charged on its existing loan portfolio by a maximum of 1.50 per cent by June 27. JN Bank will be increasing its interest rates on existing loans disbursed for more than six months on June 9 between 25 to 50 basis points (0.25 to 0.50 per cent). First Global Bank Limited (FGB) confirmed in an e-mail to clients last week that it would be raising rates on its existing loans on July 9. It said affected customers would be informed of the level of increase over the next 45 days.

Based on the duration analysis table in BNSJ and First Caribbean International Bank (Jamaica) Limited (FCIB), their portfolios will experience a significant upwards movement in fair value on interest rate increases. The other banks have most of their portfolios past the five-year mark, which means that they will benefit more in the long run from increased rates on these loans as customers pay more over a longer time frame.

FGB was the last commercial bank to revise their deposit rates upwards in December. NCBJ, JMMB Bank, and BNSJ all revised their deposit rates in the first quarter of 2021, while SBJ’s rates haven’t been revised since August 2019. FCIB and JN Bank’s website didn’t indicate the date of the last revision.

“One can recall that the increase in bank rates generally lags [between 6-8 months] after the change in BOJ policy rates. We have started to see deposit rates increase as customers seek to get better returns on their deposits, and as a consequence, this impacts our general cost of funds. As the cost of funds increases, this will have a knock-on effect on lending rates, both for the consumer and businesses clients. We have held strain, as most other institutionshave done, to cushion the effects of rising rates on the client, considering the disruption caused by the pandemic. However, this delay cannot be indefinite, considering the increase in cost of funds and, over time, as we engage our clients, the rates will adjust upwards,” said managing director of FCIB Jamaica Nigel Holness in an e-mailed response on rising rates.