Editor’s note: For the 31st consecutive year, the University of Alabama faculty experts are offering predictions for the coming year.

 

Before we go any further, here is a quick banking lesson.

The market rate of interest is the interest rate determined by demand and supply of funds in the money market. Market rates move up or down, depending on demand for funds, economic conditions and Federal Reserve monetary policy. It also is the rate a bank offers to attract deposits, rates that may match or exceed rates offered by competitors.

Market rates of interest are at record low levels, says Dr. Benton Gup, professor of finance and Robert Hunt Cochran Bankers Chair. Gup has written or edited more than 50 books on banking.

So, if interest rates are at record low levels, it’s pretty safe to predict that they are going to increase, right?

“Right,” says Gup, “but let’s not make the same mistakes that led to the failure and consolidation of thousands of financial institutions in the 1980s. Simply stated, when market rates of interest were low in the 1970s, lenders borrowed short-term funds at low rates and made long-term fixed rate mortgage loans at slightly higher rates.

“When market rates of interest soared from about 5 percent in the late 1970s to more than 16 percent in the 1980s, many financial institutions failed when their cost of funds exceeded the returns on the long-term fixed rate mortgages.”

Gup says the important point here is that mortgage lenders should not make long-term fixed rate loans unless they can hedge their interest rate risk or match the maturity of their assets and liabilities.

So, look for interest rates to go up but in a more constrained lending environment.

“Many of the biggest banks have written off, or made allowances, for bad debt and want to move forward,” Gup says.