Bankers welcomed the Federal Reserve's aggressive one-point cut in the discount rate Friday, calling it a necessary step for restoring economic growth.
But the near-term benefits for banks will probably be muted, most analysts think.
The rate cut to 3.5% -- the largest reduction in 10 years -- could raise profits marginally by widening loan spreads, bankers said. But rates are now so low that the beneficial effects on spreads are limited.
Furthermore, the Fed's move alone is considered unlikely to be enough to spur credit demand quickly.
"I don't think there's any question it gives the banking industry some breathing room," said James McDermott, president of Keefe, Bruyette & Woods Inc. But he added: "I wouldn't overstate it."
Bankers are hoping the impact will be more significant down the road.
The dramatic cut, which some major banks promptly followed by one-point reductions in their prime rate, should eventually be a shot in the arm for the economy.
Consumers will be able to refinance mortgages at lower rates, and they may start spending more if their interest costs come down. And companies may find the economics of new investments simply too attractive to pass up if borrowing costs are low.
The latest rate cut "guarantees there's enough juice in the punch bowl to liven the party up," said Jerry Jordan, chief economist at First Interstate Bancorp.
"I'd be the most surprised person in the world if we got to April 1 and didn't see a decisive pickup in consumer confidence."
The Fed announced the discount rate cut Friday morning. The rate now stands at its lowest level since 1963. The central bank folled up by pushing down its targeted fed funds rate to 4% from 4.5%.
Prime Rates Follow
The banking units of several major banking companies, led by J.P. Morgan & Co., cut their prime rate to 6.5%, effective today. Some smaller institutions announced hald-point cuts, to 7%.
Lower interest rates help banks by reducing their funding costs and making it easier for borrowers to service debt.
Net interest margins - the difference between what banks give depositors in interest and receive in loan payments - will probably widen somewhat in response to the rate cut, as they have over the course of the year.
Margins for 140 large banks follwed by Keefe Bruyette have widened from 4.27% in the third quarter last year to 4.4% in this year's third quarter.
But the benefits of lower rates have limits. Experts do not expect large gains in margins, and profits will still be hobbled by problems loans and a struggling economy.
Furthermore, lower rates mean banks can't earn as much on their loans and investments. And, contrary to the traditional belief that banks always gain from a rate cut because their cost of funding declines faster than their lending rates, few banks today have their balance sheets positioned to reap big gains from a decline in interest rates.
"We're going to make [only] a few dollars on lower interest rates," said a senior official at a New England bank.
Moreover, unusually low rates can actually hurt a bank's margins.
"Rates are getting so low I'm beginning to worry about margin compression." said Raphael Soifer, an analyst at Brown Brothers Harriman & Co. "How can I maintain if all I'm charging [on margin if all I'm chargin [on loans] is 5%?" he said.
High Fixed Costs
Banks with large retail branch networks have high fixed costs. And those fixed costs cut into the net interest margins banks earn if the rates they lend at are lower than the rates on the fixed expenses.
"Rate cuts stop helping after a point," said a money-center banker.
Low interest rates could also be a problem for banks when Congress returns to Washington in January. Last month, legislators tried to force vanks to limit the rates they charge on credit cards, saying high rates were unjustified when banks' cost of funds was so low.
That initiative was defeated, but now that banks' cost of funds is even less, it could resurface, according to a spokesman for the Consumer Bankers Association.
"This rate cut will keep the issue alive," he said.
Signs of Improvement Needed
In the short term, with consumers and companies alike laboring under massive debt burdens, and it will probably take some clear signs the economy is strengthening to entice them to borrrow any more. Neither the massive layoffs recently announced by IBM and General Motors nor the dismal economic statistics emanating from Washington are doing much to bolster consumer confidence.
Consider the customers of Bucks County Bank in suburban Philadelphia. Dale Edwards, senior vice president and head of consumer lending, said lower rates are only part of what's needed to induce consumers to borrow and spend more.
"Consumers aren't just concerned with the interest rate on a loan," he said. "They're concerned with repaying the principal" because they are worried about the economy.
And on the corporate side, banker were equally cautius. While corporate America's debt costs are coming down, the operating environment isn't getting any better, according to James Lee, a managing director at Chemical Banking Corp.
"That's the nub - there is no clear reason to expand at the present time," hence, nothing to spur corporations to borrow more.
Bill Goodwin contributed to this article.