As the interest rate cycle continues to move still higher, we are regularly hit with the news that this is good for savers who are feeling the full benefit, but who really makes the money as interest rates rise?

You will not be surprised to see that the banking corporations can very often increase their profit margins in a rising interest rate market, and the chances are that you will not even notice it.  This is done using a very simple trick - increase borrowing costs by more than savings rates, thereby increasing your profit margins in an instant - but does it really have a major impact?

Let us show you how the situation can work :-

Prior to the last interest rate rise, let us assume the following :-

Base Rates   5.50%

Consumer Saving Rates   5.25%

Consumer Borrowing Rates 6.50%

In this situation a bank would make 0.25% on each pound of savings, if they were to put that straight back on deposit, however if they were to lend that to a customer  they would make 1.25%.  The profit margin for each situation would be :-

Placing consumer savings on deposit :-

100 * (0.25/5.25) = 4.76% profit margin

Lending consumer savings to borrowers :-

100 * (1.25/5.25) = 23.8% profit margin

However, let us assume that interest rates rise to 5.75% (as they have), and consider the following changes :-

Base Rates   5.75%

Consumer Saving Rates   5.40%

Consumer Borrowing Rates 6.80%

As you will see, in this situation savings rates have increased by less than the rise in base rates, while borrowing rates have been increased by slightly more.

The calculations are now :-

Placing consumer savings on deposit :-

100 * (0.35/5.40) = 6.48% profit margin

Lending consumer savings to borrowers :-

100 * (1.40/5.40) = 25.92% profit margin

While these increases in the profit margin of the banks may not sound much on the face of it, when you consider that the industry deals in billions of pounds each year, even a small increase in profit margins can have a massive impact upon the profitability of a company. 

This is just one of the ways that the banks use interest rate rises to increase their profitability, a technique which very often goes unnoticed unless you actually sit down and work out the figures!