What Are Interest-Sensitive Assets?

Interest sensitive assets are financial products that are vulnerable to changes in lending rates. The adjustable-rate mortgage is an example.

Banks and their customers both are affected by interest-sensitive assets.

Key Takeaways

  • Interest-sensitive assets become more profitable or less profitable as lending rates increase or decrease.
  • If interest rates rise, a bank earns more profit from mortgages and other loans.
  • If interest rates fall, the consumer keeps more money and spends it elsewhere.
  • The trends in overall interest rates drive the economy or slow it down.

When lending rates increase, banks can earn more money on adjustable-rate mortgages and credit cards. They also can charge more for new loans such as car loans and fixed-rate mortgages.

The banks can increase their profitability while remaining competitive. Consumers and business borrowers feel the impact. If rates increase, they pay higher interest rates for all of those products.

The reverse is true as interest rates fall. The bank makes less profit from their loans. Consumers and businesses pay less interest and therefore have more disposable income.

Understanding Interest-Sensitive Assets

All interest rates follow the general direction set by the Federal Reserve Open Market Committee when it meets about eight times a year to assess the state of the economy. The governors may act to slow down the economy if they think it's growing too fast or boost it if they think it needs to speed up.

Interest rate sensitivity affects many businesses beyond banking. Homebuilders and realtors are particularly helped or hurt by interest rate changes.

They achieve that by raising or lowering the key lending rates, including the prime lending rate that banks charge their most trustworthy customers. All other lending rates derive from that prime lending rate.

Interest-sensitive assets are the financial products that are most affected by changes in borrowing rates.

Other Interest-Sensitive Businesses

Interest-sensitive assets are by definition financial products, but interest rate sensitivity affects many businesses beyond banking.

These are primarily businesses that depend on borrowed money, either directly or indirectly through their customers. Homebuilders and realtors, for example, are in an interest-sensitive sector, real estate. When rates climb, consumers hold back on buying. The retail sector, however, tends to thrive when interest rates are low. Their customers have more disposal income to spend.

Analyzing Interest-Sensitive Assets

Financial professionals analyze interest rate sensitivity in a variety of ways and from many angles. This analysis is typically done for institutional lenders as a way of determining the risk of its lending policies.

Lenders and corporations also analyze the interest rate sensitivity of their investment assets as a part of their balance sheet reporting.

Benchmarks under close watch for interest rate changes include the six-month Treasury bill rate, the London Inter-bank Offered Rate (LIBOR), and the Federal Reserve's prime rate. The indexed rate of these products are the key elements that analysts follow when considering interest sensitivity and that banks use when setting their rates for various financial products.

Coping with Interest-Sensitive Assets in Investment Portfolios

An individual investor's portfolio needs to be scrutinized carefully in times of interest rate volatility, especially if they are heavily invested in bonds.

When interest rates rise, bond prices fall.

Generally, when interest rates are rising, portfolios that concentrate on fixed-income investments can be adjusted to earn a higher income from variable-rate investments. When interest rates are falling, the portfolio can be adjusted to place a greater portion of assets in fixed-rate investments that provide higher coupons.

Floating-rate bonds are one type of product that investors can consider in order to stay on top of interest rate changes without the effort. These bonds pay current market interest rates.