Question

Is it true that an increase in interest rates always lowers the net worth of a financial intermediary? Explain why that is.

Answer 1

I don't think that this statement is completely true because increase in interest rates will not be always leading to decrease in the net worth of a financial intermediary because financial intermediaries is always tasked with acting as a intermediary between savings and depositors like bank and these financial intermediaries like Bank, if properly managed can take optimum advantage of increasing interest rate and increase their margin of overall profit in such scenarios because increase in interest rate will be indicating increasing demand in the economy

Increase in interest rate is often characterized by increase of inflation because the central bank of a country will be trying to increase the interest rate in response to increase of inflation in an economy and increase in inflation in an economy will be reflecting that there is optimum level of generation of demand into the economy so the bank will be able to lend more at a higher rate of interest and it will have to pay more also on the deposits but the margins has to be maintained and some banks are in a stronger position to maximize their profit margins in such scenario, where the interest rate is high, so these banks will be able to maximize their overall profits in increasing interest rate regime also.

So, it is not fair to say that increase in interest rate will always be having an negative effect on the net worth of financial intermediary because if there is proper management of the resources in the books of accounts and proper lending and proper payment of the rate of interest on deposits, then the banking industry can maximize their overall profits in increasing interest rate regimes also.

Therefore I am not agreeing to this statement in whole, because there are times when the banks are not able to cope with increasing interest rate because they are not in a position of leadership, whereas when the banks are in a position of leadership and they are commanding a premium, they will be generating a higher rate of return in such higher interest rate environnement.