The Fed is set to raise interest rates in 2022 faster than it has in decades. Credit Unions knew higher interest rates were on the way, but few expected the extraordinary pace at which they are now expected to rise. This scenario is pushing credit unions to re-evaluate both their lending and investment strategies.
When the Fed raises the federal funds target rate, the goal is to increase the cost of credit throughout the economy. Higher interest rates make loans more expensive for both businesses and consumers, and everyone ends up spending more on interest payments. It simultaneously encourages people to save money to earn higher interest payments. This reduces the supply of money in circulation, which tends to lower inflation and moderate economic activity. Rate hikes discourages borrowing, as the cost of money is now more expensive.
As interest rates climb, how should credit unions respond and strategize?
1. Don’t panic.
2. Be prepared.
Impact of Fed rate hike and how can Credit Unions navigate
For most credit unions, providing loans to their members is, at the core of what they do, and so prudent growth of their loan portfolio is always going to be a key goal. Regardless of the interest rate environment, if priced correctly, loans always produce a higher rate of return than investment portfolios.
Change in interest rate may affect those credit unions who have placed significant portions of their loan portfolio in historically low-yielding loans or extended investment terms to enhance yield. As a result, they will have to wait for these assets to mature and re-price at the higher interest rate.
Another challenge is, consumers have been used to low interest rate for some time and the sudden rise in interest rates produces a psychological effect that might lead to some consumers turning away. Key to remaining competitive in this situation will be aligning rates with relationships.
Tactics for a rising interest cycle
1.Benchmarking solutions in pricing: Credit Unions will have to design their strategies and price products to retain their customers and align with primary relationships. Primary relationships that bring not only deposits but payments and credit business.
2. Multi scenario planning: Plan for a wider-than-usual range of potential market conditions, given the variety of fiscal, monetary and other macro-economic scenarios.
3. Effective communication plans: Business should overinvest in communication plans. Communicate early about the price sensitivity and special offers.
Net result
Credit unions, like other depository institutions, engage in maturity transformation. They take in deposits on which they pay short-term interest rates and lend money in the form of longer-term loans at long-term rates. A credit union’s net income largely reflects the difference in their short-term deposit rates and their long-term lending rates. The difference between economy-wide, long-term rates and short-term rates is a key indicator of the pressures on credit union net income. Credit Union managers should understand how their income statements and balance sheets could change under a variety of interest rate scenarios and consider the risks and opportunities they pose to their credit union’s financial performance.
The key to remaining competitive will be aligning rates with relationships. Success depends on the overall goals and strategy, which can vary from credit union to credit union.
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