The Impact of Interest Rate Movements on Bank Profitability: A Literature Review
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Keywords
interest rates, bank profitability, net interest margin, monetary policy, credit risk
Abstract
Interest rate changes are one of the most important macro-financial factors affecting bank profitability. As financial intermediaries, banks earn a large share of their income from the difference between interest received on assets and interest paid on liabilities. Therefore, changes in policy rates, market rates and the slope of the yield curve can influence banks’ net interest margins, funding costs, loan demand, credit quality and overall profitability. This paper reviews existing literature on the relationship between interest rate changes and bank profitability. The review shows that higher interest rates may improve profitability when loan rates adjust faster than deposit rates and when banks benefit from wider margins. However, higher rates can also increase funding costs, reduce credit demand and raise borrower default risk. In contrast, low interest rates may support economic activity but often compress margins when deposit rates cannot fall further. The paper argues that the impact of interest rates is conditional rather than uniform, depending on bank size, balance sheet structure, market power, maturity transformation, competition, monetary policy conditions and the broader macroeconomic environment.
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