Where are Interest Rates Headed? DBS Group Holdings Ltd’s CEO Shares His Thoughts

Singapore’s largest bank, DBS Group Holdings Ltd (SGX: D05), is expecting two interest rate hikes this year.

The bank has also guided to achieve a net interest margin (NIM) of 1.8% for 2017. For perspective, DBS Group achieved a net interest margin of 1.8% in 2016 as well. Embedded in the 2017 guidance is the bank’s anticipation of two interest rate hikes for this year. Banks can benefit when interest rates rise. To understand how this works, we have to understand how banks earn their money.

Inside the banking machine

My fellow US Fool, John Maxfield, has a simple explanation on how banks earn their keep:

“The way I like to simplify in my own head, because I have a pretty simple mind [laughs], is that a bank is really nothing more than a retail type of operation, but instead of a bookstore that sells books, banks sell money.

And interest rates are the price of money. That is, when you get a loan, the bank is basically selling you that money to use for a time being.

The price that you are paying for that is the interest rate on that. So, as interest rates go up, the price of money goes up. And as the price of money goes up, well, so do bank revenues. So, that is a really good thing.”

In essence, higher interest rates allow banks such as DBS Group to lend out money at a higher rate. Going back to the net interest margin target of 1.8% in 2017, DBS Group’s CEO, Piyush Gupta, said during the bank’s 2017 first quarter earnings presentation:

“I think we still have a good chance of getting there if rate expectations materialise.

But if our expectation of rate hikes comes through and the pass-through to the Singapore-dollar comes through, I think we should be able to achieve 1.80% for NIM [net interest margin].”

Said another way, in keeping its net interest margin expectations at 1.8%, DBS Group believes that there is a chance that two interest rate hikes will happen during the course of this year.

Now what?

Higher interest rates would mean loans to companies will become more expensive.

But as fellow Fool David Kuo points out, a rate rise usually comes because the economy, as a whole, is getting better. A better economy could mean that companies are earning more profits too.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong doesn’t own shares in any companies mentioned.