Friday, August 28, 2009

Use Yield curve for financial intermediaries

The slope of the yield curve is critical for financial intermediaries, especially commercial banks, savings and loan associations, and savings banks. A rising yield curve is generally favorable for these institutions because they borrow most of their funds by selling short-term deposits and lend a major portion of those funds long term. The more steeply the yield curve slopes upward, the wider the spread between borrowing and lending rates and the greater the potential profit for a financial intermediary. However, if the yield curve begins to flatten out or slope downward, this should serve as a warning signal to portfolio managers of these institutions.
a flattening or downward-sloping yield curve squeezes the earnings of financial intermediaries and calls for an entirely different portfolio management strategy than an upward-sloping curve. For example, if an upward-sloping yield curve starts to flatten out, portfolio mangers of financial institution might try to "lock in" relatively cheap sources of funds by getting long-term commitments from depositors and other funds-supplying customers. Borrowers, on the other hand, might be encouraged to take out long-term loans at fixed rates of interest. of course, the financial institution‘s customers also may be aware of impending changes in the yield curve and resist taking on long-term loans or deposit contracts at potentially unfavorable interest rates.

No comments: