In the long run, rate cut by Fed will be favourable for most US banks: Moody's

A new report by Moody's ratings says the likely rate cut by Fed will be favourable for most of the US banks in the long run.

"Initially, the rate cuts will be credit negative for most US banks. We expect their deposit costs to reprice downward more slowly than their loan yields, constraining net interest income, which is most banks' largest revenue source." Said the report

It adds in the long term reductions in deposit costs will catch-up and strengthen net interest income for banks. Additionally, if lower rates prolong economic growth it will help banks maintain and improve their asset quality.

The deposit costs are expected to decline more slowly than loan yields, which will compress net interest income (NII). This may impact profitability across the sector, in the short terms as banks will have to adjust to the lower rate environment.

But looking ahead, the impact of rate cuts is expected to gather momentum in the long run. Analysts predict cumulative rate reductions of 200 bps by the end of 2025. The report adds, as deposit costs eventually catch up with the lower rate environment, banks' net interest income should stabilize and improve.

Furthermore, if lower rates prolong economic growth, it will help banks maintain and potentially enhance their asset quality. This is particularly relevant for sectors like commercial real estate (CRE), which has been a struggling asset class for many regional banks. Lower rates will support loan refinancing and improve debt affordability for floating rate borrowers.

"Cumulatively, as rate cuts become more impactful, that will support commercial real estate (CRE) loan refinancing, a challenged asset class for many regional banks. Lower rates will also improve debt affordability for floating rate borrowers" the report added.

On the downside, increased loan demand could put pressure on banks' liquidity as more funds are directed toward lending activities.

Another positive aspect for banks is the potential improvement in capitalization. A sustained decline in long-term interest rates will reduce unrealized securities losses, providing a boost to banks' economic capital.

Overall, while US banks are likely to experience short-term challenges from rate cuts, but in the long-term outlook appears more optimistic.

The Federal Reserve is expected to cut interest rates for the first time since its aggressive rate-hiking cycle began in March 2022.

On Wednesday night India time, as per Moody's report the Fed is likely to reduce the federal funds rate by at least 25 basis points (bps), marking a reversal after cumulative increases of 525 bps between March 2022 and July 2023.