With the Federal Reserve beginning interest rate normalization, major banks are already jumping on the opportunity to increase prime rates, bolstering their profit margins and potentially supporting financial sector exchange traded funds.
On Wednesday, banks including Wells Fargo & Co. (NYSE: WFC), JPMorgan Chase & Co (NYSE: JPM) and Bank of American Corp. (NYSE: BAC) raised their prime rates to 3.5% from 3.25%, Reuters reported. [Bank Stocks, ETFs Continue to Attract]
Prime rates are the interest rates that commercial banks charge credit-worthy clients and are typically determined by the federal fund rate, or overnight rate that banks lend to one another.
Major banks hiked their prime rates in response to the Fed’s decision to raise its main short-term rate to a range of 0.25% to 0.5% from its previous range of 0% to 0.25%.
However, these banks have held off on raising the deposit rates, or the interest rate banks pay to account holders. The average interest rate on a savings account is about 0.48%, according to Bankrate.
“We won’t automatically change deposit rates because they aren’t tied directly to the prime,” a JPMorgan Chase spokesperson told CNBC. “We’ll continue to monitor the market to make sure we stay competitive.”
Banks do not have much of incentive to raise deposit rates as there is still plenty of cash on hand.
“Loan rates will rise but that’s not necessarily the case for deposits as banks are already flush and don’t need to raise rates to bring more in the door,” Bankrate.com Chief Financial Analyst Greg McBride told CNBC.
Consequently, the wider discrepancy between deposit and prime rates could translate to improved profit margins and a potentially stronger financial sector ahead. [Bank Sector ETFs Could Lead as Rates Rise]
ETF investors can also capitalize on the shift in banking policies through diversified financial sector plays, such as the iShares U.S. Financials ETF (NYSEArca: IYF), Financial Select Sector SPDR (NYSEArca: XLF) and Vanguard Financials ETF (NYSEArca: VFH).
The major banks that have changed their prime rates are among these financial sector ETFs’ top holdings. For instance, IYF includes WFC 6.4%, JPM 6.1% and BAC 4.5%. XLF holds WFC 8.7%, JPM 8.3% and BAC 6.1%. Lastly, VFH includes WFC 6.7%, JPM 6.1% and BAC 4.5%.
Financial Select Sector SPDR
For more information on the financial sector, visit our financial category.
Max Chen contributed to this article.