Why Do Net Interest Margins Behave Differently across Banks as Interest Rates Rise?

he Federal Reserve began raising the federal funds rate to reduce persistent inflation in March 2022.Rising interest rates can influence bank profitability both positively (by increasing payments from those with floating-rate debt) or negatively (by forcing banks to offer higher returns to their depositors).Which of these effects dominates depends on both the speed with which loan and deposit rates adjust to rate hikes and on banks' business models.Although most banks became more profitable during the 2022-23 tightening cycle, a smaller group of banks saw consistent decreases in their net interest margins (NIMs).Understanding why these banks' NIMs declined may provide useful insight to policymakers.With the spring 2023 banking turmoil revealing significant vulnerabilities on some bank balance sheets, banks experiencing persistently decreasing margins could be more susceptible to further rate hikes or shocks that could affect the quality of their assets.In this article, we explore the differences in bank NIMs and their drivers over the 2022-23 tightening cycle.We find that the distribution of bank NIMs widened over this period, largely due to differences in banks' business models.Specifically we find that "margin-decreasing" banks were more involved in capital markets, with higher shares of Page numbering may change upon this article's inclusion in the coming issue of the Economic Review.