The interest rates tend to be going higher and the banks tend to bet that they would make some money with this move. It isn’t surprising that the $5bn bet by JPMorgan Chase is boldest, according to Fortune, though it isn’t clear how the money would be made.
JPMorgan’s CEO, Jamie Dimon, in his annual letter for shareholders, wrote that as they’re currently positioned, if the rates had gone up by basis points of 300, their pre-tax profits will rise by $5bn approximately over 1-year period.
The projections by banks that high interest rates would lead to high profits appear to be based on logic, upon this premise that spread between lending and borrowing costs increases. Though in past, most banks got burned due to increasing interest rates.
This much is also admitted by Dimon in the annual letter.
Dimon admitted as much in his annual letter, writing that although it’s totally possible that they would manage without much suffering, some pretty coherent arguments are also there which suggest that there can be notable negative consequences.
Further, Dimon suggested that the preparation is key factor to determine whether the banks suffer or benefit from the increasing rates and explained difference between recent history’s two occasions when the long-term and short-term rates increased around three hundred basis points in a year.
During 1994, move was quite unexpected and it caused much loss financially for all those who were not prepared. During 2004, while increases were quite foreseen, damage was much limited, according to Dimon.
Though Dimon claims that his bank tends to be positioned and Dimon is clearly aware of risks, according to Fortune, still it is quite hard to view how bank would make $5bn from 3% interest rates’ rise.
A report was released by Merrill Lynch outlining those banks whose per share earnings are very sensitive to the rates of interest. JPMorgan wasn’t even on list. As their activities of banking tend to be much diverse and they have global operations, megabanks were thought to be cushioned from the increased rates’ impact.
It is speculated by Fortune that JPMorgan might have stockpile of swaps of interest rate. These derivatives will pay off within environment of increasing rates. Though, betting against the rates and then not getting it right will be pretty risky for bank which yet has to live down losses of London Whale.
One other possibility is the referring of $5bn bet of Dimon to the lending profits, as said by Fortune. But, it’s the long-term rates which have recently been rising. And as it was pointed out by Nomura in one report lately, lending profits doesn’t witness much growth when the short-term rates stay low.
Though the analysts do not know where the potential billions of JPMorgan would come from. According to Fortune, the analysts contacted have not done their math and they say that even when they do try, this will be quite a complex question. Instead, they only are taking the word of Dimon for it.