Elevated inflation will not necessarily hurt bank profitability, but abrupt rate hikes or inexperienced bank management could, says Moody’s Investors Service in a new report on the U.S. banking sector.
The rating agency said that, while banks that are highly exposed to interest rate risk have suffered in the past when rates rose to combat inflation, there isn’t a direct historical correlation between higher inflation and weaker earnings.
“Elevated inflation has not previously led to a direct decline in U.S. banks’ profitability or an immediate rise in bank failures,” it said.
Additionally, the report noted that loan-loss provisioning has not been historically correlated with inflation, “often because subsequent interest rate hikes have been gradual, giving banks and borrowers time to adjust.”
However, in the past, episodes of high inflation that led to sharply rising interest rates, “which hurt the economy and induced subsequent destabilizing business model and regulatory changes,” did contribute to a wave of failures at exposed banks and other lenders, it noted.
This time around, “The banks are in good shape to maintain their profitability through the current period of elevated inflation,” Moody’s said.
Higher inflation could even prove beneficial, it noted.
“If rising inflation leads to higher interest rates but does not weigh on the ongoing expansion, that will unlock the value of banks’ huge core deposit franchises, a boost to profitability,” Moody’s said.
Currently, the rating agency expects inflation to ease somewhat in 2022, while remaining above the long-term average.
However, if high inflation persists beyond the expected time frame, “the potential for credit negative responses by banks will rise,” it warned.
“How banks respond to persistently high inflation will influence the ultimate impact on their profitability,” it said. “Because bank management teams have had no experience operating in a persistent inflationary environment, their strategic responses in that scenario could have unintended, credit negative implications.”