Inflation refers to an increment in overall price levels; as a result, money value depreciates. However, inflation is significant for banks and financial institutions because they normally deal with nominal financial tools (these are instruments that are usually denominated in fixed dollar values). For instance, if a bank generates a loan, it utilizes nominal financial tools (mortgages, notes, commercial paper and alternative financial securities) which shows the obligation of a debtor to the bank. On the other hand, if a bank borrows nominal financial tools are issued to creditors (debenture, acceptances, and deposit liabilities).
Inflation, however, can guarantee return on value especially for the finance industry and this can offer a competitive advantage. Nonetheless, high inflation could lead to high inconsistency within the interest margin as well as the stock returns. Additionally, if the economy experiences high inflation, long term financial activities reduce because intermediaries lend less and the capital investments become ineffective.
How Your Bank Can Survive Inflation
Banks need to slowly raise their interest rates so that inflation can remain at manageable levels. Bank credit is usually affected by inflation and this means that the rate of return has to be sufficient enough to compensate any capital attrition arising from inflation.
Furthermore, for better customer relations banks need to educate the public about the realities of inflation and how it affects the customer. This will help retain the customers because they will have a better understanding of what is happening to them and the effects incurred in their finances.
Banks could also lower the dividends in order to curb inflation. Retentions can be raised to match the rate of return. Instinctively, this will protect the bank’s capital if the rate of return supersedes the inflation rate.