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3 Biggest Challenges of Rising Interest Rates on Global Banks

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Cross-border trade is booming, and payment volumes are already back to pre-pandemic levels. But increasingly high interest rates in the United States and Europe could threaten this comeback story for global banks and their enterprise customers. In part one of a closer look at the broader challenges imposed by rising interest rates, let’s focus on the impact on banks. 

The International Monetary Fund highlighted concerns in the recent Global Financial Stability Report, and found that rising interest rates have increased risks for banks and nonbank financial intermediaries alike. These worries were echoed in Ripple’s 2023 New Value Report, in which one-third of financial decision makers cited high interest rates as a top challenge for cross-border payments.

While the degree of impact may vary by country — depending on its regulations, currency and the volume of transactions — one thing is certain: the traditional approach to cross-border payments is no longer sustainable. For global banks that depend on cross-border transaction volume, the implications of this new rate environment are profound. Ultimately, an efficient, integrated payments solution is necessary to maintain longevity during economic turmoil. 

Here are three specific challenges to the overall health of global banks as interest rates rise:  

  1. Shrinking Customer Portfolio 

In general, higher interest rates can trigger a decline in the number and variety of customers that a bank serves which can affect overall returns. As returns fall, clients may explore alternative investment options outside of traditional banks, leading to a loss of tangible assets. Even the mere perception that a bank is losing value or the number of depositors is decreasing can lead to a run on withdrawals. 

This is evident in U.S. and Eurozone data indicating that rising interest rates have already led to a reduction in total bank deposits. In the U.S., deposits have fallen by 3.3% since the Federal Reserve initiated interest rate hikes. Meanwhile, the Eurozone has seen depositors withdraw 1.5% of total deposits over the past five months, and February saw the largest monthly decline in holdings since tracking withdrawals began in 1997.

Rising interest rates can also expose banks to greater foreign exchange (FX) fluctuations and expenses. Banks that respond by imposing additional charges or higher fees on cross-border transactions could drive even more customers towards alternatives like fintechs. 

Taken together, these trends can significantly reduce the number and types of bank customers, leading to a more homogenized portfolio. The risk factors presented by a shallower pool of similar customers is especially acute with a potential recession on the horizon, and as other consequences of rising rates put banks under pressure to find new customers. 

  1. Constrained Credit, Reduced Liquidity

Higher interest rates have a direct, negative impact on the availability of credit – as rates rise, so too does the cost of credit. Constrained credit supply leads to an overall reduction in liquidity in the financial system, which slows or inhibits financial activity of all types, including cross-border payments. 

U.S. banks have experienced this firsthand, already taking on unrealized investment asset losses of roughly $620.4 billion as the Federal Reserve has tightened monetary policy. A potential looming recession would only exacerbate the issue and further limit loan growth. 

To counter this drop in loans, banks must work even harder to identify client segments that will take on loans at higher interest rates. But, as mentioned above, rising rates may already have caused shrinking client portfolios, ramping up the pressure on banks to retain existing customers and attract new ones.

  1. Limited Investment and Economic Growth

Finally, high interest rates can stifle investment activity and economic growth more broadly. Rather than invest in innovation and expansion, businesses facing elevated borrowing costs may be hesitant to widen operations or participate in cross-border trade. This can hamper economic growth and global payment volumes, with negative consequences for the banks serving these sectors. 

With less available capital to invest, banks and financial institutions might then pull back on their own investments in emerging technology or new products. This can extend product development cycles and limit the availability of new products for customers, further cutting into revenue.  

A lack of investment and expansion also limits a bank’s ability to tap growth from new customer segments like small- and medium-sized enterprises and those in emerging markets which are expected to outpace that of developed markets in 2024.  Notably, Latin America shows considerable potential, and the rapidly expanding tech industry, particularly in the IT outsourcing sector, presents lucrative opportunities. A lack of engagement in these emerging markets would logically cut into overall cross-border transaction volume and growth.

Power of Crypto-Enabled Payments

Crypto and blockchain could hold the key to a thriving global banking system amidst this evolving rate landscape by supercharging cross-border payments, boosting liquidity and providing a source of much needed growth into emerging markets.

Blockchain-powered payments enable faster transactions, enhanced global engagement and represent an estimated $10 billion in cost savings for banks—all of which could attract new business and counterbalance the dangers of rising interest rates. Global finance leaders agree, citing  faster payments and cost savings as the top two value propositions for incorporating crypto into their cross-border payments business.

These advantages of speed and price can offset any fees banks might add to their cross-border products in response to rate increases, helping retain or even attract customers that might otherwise defect. Modern payments technology can unlock capital that would normally be trapped in pre-funded accounts, helping enhance liquidity levels constrained by more expensive credit. And simpler, more efficient international transactions could help sustain or open corridors and payment flows into and out of emerging markets that would be restricted if banks respond to rising rates by pulling back on investments and growth. 

Corporate treasury management is one such area that stands to gain from a payments stack enhanced by blockchain; around-the-clock access to global payment rails affords greater operational flexibility and agility for financial institutions and businesses alike.  “[This] relieves the finance and treasury function of a variety of different burdens they face using legacy solutions, including wire cutoff times, holidays and banking hours — all of which make traditional cross-border payments a complex labyrinth to navigate,” Aaron Sears, Ripple’s Managing Director of the Americas, said in a recent interview with PYMNTS.

Ripple solutions make it easy for banks to capitalize on all of these advantages conferred by blockchain-powered cross-border payments. Ripple’s global payments network represents 90% of the FX market so banks and their customers have a plug-and-play way to engage in emerging markets and new corridors and focus on gaining a competitive advantage amidst an unsteady global economy.

Learn more about how to sustain growth and expand revenue even in the face of rising interest rates.

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