The large Singapore-based bank lays out what higher rates mean for banks around the world, and which regions are most likely to benefit from the process.

The world’s banking industry, which has seen margins pummelled by ultra-low interest rates since the 2008 financial crisis, is likely to benefit now that central banks are tightening monetary policy in the West and specific regions, Singapore-based DBS said in a note.

DBS said that it is positive on the global financial sectors. 

“Against a backdrop of global economic recovery, key banking indicators such as net interest margin (NIM), credit charge, fee income, and loan growth are likely to improve. Moreover, with value plays back in focus, we expect financials to outperform the broader market,” Joanne Goh and Yeang Cheng Ling, senior investment strategists at DBS Bank, said in a note.

“Earnings upgrades should continue in this sector as the [US] Federal Reserve is expected to deliver more hikes than its previous forecast. The sector has de-rated over the years post-global financial crisis [of 2008] in a tight regulatory and low interest rate environment. As early cyclicals, they can take advantage of a pick-up in investment and consumer spending, as well as rising interest rates in a reflationary environment. Valuations should also rise accordingly with rising bond yields,” they said. 

The strategists gave one caveat – different countries aren’t on the same interest rate path.  

“We prefer US banks and Asia banks, followed by Europe banks,” DBS said.

Since rising inflation figures came out in many developed countries, wealth managers have had to reframe clients' expectations to a different world. For the past decade or more, ultra-low rates have hit bond and stock yields, encouraging large inflows into areas such as private markets and real estate. Banks' margins have suffered. In Switzerland, a regime of negative interest rates has hit margins, and negative returns on cash encourage clients to move into higher-risk assets than they'd normally be happy with.

Rising US
“With the Fed being seen as the most vigorous in rising interest rates, US banks will benefit the most in this change of stance among central banks. We believe street analysts have yet to price in more rate hikes before the Fed’s dot plot confirms this, leading to a general earnings upgrade for the sector. Lending activities should also be robust as the US economy returns to normalcy after two years of pandemic slowdown, driven by corporate capex and consumer spending. A still-loose financial liquidity condition means banks should have the capacity to lend and work their balance sheets hard in a reflationary environment,” the strategists said. 

In Europe, there will be fewer rate rises. 

“The European Central Bank pivot will only bring marginal rate hikes in the eurozone and thus the benefits of rising rates will be felt less among European banks. We are selective on European banks as NIM expansion is unlikely to be sustainable in a low interest rate environment. Moreover, European banks are still healing from the European sovereign debt crisis 10 years ago, and their assets will be sensitive to higher bond yields,” the bank continued. .

The central bank which is least likely to raise rates is the Bank of Japan. 

“Unlike other central banks which are reducing bond purchases and hiking interest rates, the BOJ is expected to maintain its monetary policies of negative interest rate and yield targeting. Inflation in Japan is still low and far from BOJ’s 2 per cent target. Although there is upstream cost pressure, manufacturers are unable to pass through costs effectively in Japan due to demand that has yet to gain a strong footing. We do not see impetus for loan growth as the economy is still recovering from subsequentCOVID waves and remains closed for international travellers, and domestic sentiments are weak. We look for Japanese banks which are able to profit from overseas gains,” the bank said. 

DBS suggests that Chinese banks are a “buy” because they offer consistent dividends. 

“Since the start of 2022, China banks have risen more than 10 per cent, driven by attractive valuations as the flight-to-safety is in play amid a stock market rout. Our preference is to stay with China’s large state-owned banks that have a better balance sheet quality, stronger deposit franchise, and lower cost of funding to support their earnings trend and sustain attractive dividend yields. Banks in China distribute 30 per cent of their net profit after tax in the form of dividend payout, which we think is sustainable as evidenced over the past few years over various cycles,” DBS said.

Turning to its home turf of Singapore, DBS said that Singapore banks are “poised for re-rating as the global monetary tightening cycle begins.”

“With the Fed expected to hike rates 175 bps in the next two years, NIM expansion will be the biggest boost to the [profit and loss]. Our sensitivity analysis indicates that every 25 bps increase in interest rates would result in net interest margin increases of 3 to 7 bps, with a corresponding 2 to 6 per cent increase in net profit across Singapore banks,” it added.