Bank of America Corp (BAC): The Big Bank Temptation in 7 Charts

4. Profits are being squeezed

Source: FDIC

Banks today may be profitable, but that profit is increasingly hard to come by.

Fundamentally, banking is simple: banks accept deposits and pay the depositors a small amount of interest. They then use those deposits to make loans and charge a higher interest rate. The difference, the net interest margin, is loosely equivalent to gross profit.

Since the Savings and Loan crisis in the late 80s and early 90s, the industry’s net interest margin can be seen steadily decreasing. This pattern will continue, painfully so in the short term.

There are two numbers to consider for this analysis: the interest rate paid on deposits and the interest rate paid on loans. When interest rates rise, the rate paid on deposits will always rise faster than that paid on loans. This is because loans are generally longer term and the interest rates are generally fixed rate or variable rate that adjust periodically but not instantly.

When the Federal Reserve does move to raise interest rates, the rates paid on deposits will increase faster than the rate on loans. Therefore, the net interest margin will squeeze even further.