The Federal Reserve made a slight raise for the federal funds rate by 25 basis points based on the latest and greatest economic data available (household spending, employment information, business spending, etc…). While the current interest rate environment has been a struggle for banks to boost profitability – the only meaningful move for interest rates in the future – is upward.
Higher interest rates will translate into greater earnings power for banks. Additionally, after the 2009 financial crisis, banks overall have become more strict on lending requirements which means their balance sheets are cleaner and the credit worthiness of borrowers is greater. I’ve noticed this not only through reading through various 10-K annual reports of companies such as Bank of America (NYSE:BAC), JPMorgan (NYSE:JPM), and Wells Fargo (NYSE:WFC) – but also merely observing the advertising campaigns targeting high-end credit card customers. Banks are in fierce competition right now which is why they are offering various perks and rewards in order to get the attention of borrowers.
The banks can offer these incentives to credit worthy borrowers because the seller or merchant bears the real cost; the bank bears the risk. Most people also do not pay off their credit cards right away, which is why most of the money is made with interest income. The banks also make money on charging the merchant per transaction (usually 2 – 3%), if the seller does not accept credit cards, most customers will use an ATM which now also has a fee (whoever invented ATM fees is an evil genius). Other income comes from bank fees (late fees, a bounced check fee, transfer fees, etc…) and investment income.