Interest rates and their impact on financial services companies 

Federal interest rates remain a significant factor in the daily operations and long-term strategies of various financial service companies, as rising or declining interest rates can alter a company’s strategy and outlook. It can change the types of loans and amounts of money a company may potentially borrow, while also affecting things such as the valuation of securities currently held by the company, any future investment ventures and future cash flow forecasts.

At this point in 2024, interest rates remain very high, as the economy has been burdened with inflation since the COVID-19 pandemic, leading to numerous rate hikes in the past three years, with eleven of those coming between March 2022 and July 2023. On Sept. 18, 2024, the Fed reduced interest rates by 50 basis points, which represented a reduction for the first time since March 16, 2020. Even with this reduction, interest rates remain well above the average from the past fifteen years.

Impact on financial services

As mentioned above, there are various impacts that rising interest rates can have on a company. One of these impacts is the effect on the diversification of a company’s investment portfolio. In the case of investment companies, or any company that holds securities, diversifying your portfolio is a keyway to hedge against any potential losses in riskier investments. When hedging with investments of lower risk, higher interest rates can affect the decision making going into how an investor diversifies.

Looking at trends in the financial services industry, bonds and related low risk securities have become increasingly popular amongst all types of companies, from your typical investment fund to even broker-dealers. They are a way of hedging the risk of other higher risk investments, such as stocks, options, etc. Bonds are a good example of the variables involved in the decision making when a company builds or alters their portfolio. If you hold an existing bond and interest rates increase, the value of your existing bond will fall. If you are still in the market for buying bonds, increasing interest rates will provide a higher yield for newly issued bonds. The decrease in value of existing bonds held by a company may lead them down different avenues of hedging, i.e. looking to purchase newer bonds at a higher interest rate. While the outcome of rising rates may not be so negative for companies looking to get into bonds, companies that have established bond portfolios will see the value of them decrease. Fortunately, this will only be a paper loss, unless the company intended to sell the bond before maturity, in which case the loss will become realized. This is a win for bond buyers and possibly a loss for bond funds, which regularly buy and sell underlying holdings.