Date of Award

January 2017

Document Type

Thesis

Degree Name

Master of Science (MS)

Department

Economics & Finance

First Advisor

David T. Flynn

Abstract

As the Economy continues to recover from the ‘Great Recession’, the Fed is taking a very cautious approach to increasing interest rates; which have been at historical lows the past several years. If interest rates are increased too quickly, or by the wrong amount, there may be negative ramifications on economic activity. With the slow recovery following the ‘Great Recession’, commercial banks in the U.S. have struggled to return bank performance to pre-recession levels, as the low interest rate environment has had a negative impact on profitability and overall bank performance (as have changes in regulation). It cannot be argued that commercial banks will receive a higher return on investment when interest rates are high; however, interest rates and economic activity are negatively correlated. So, which is more beneficial to maximizing bank performance in the current market environment: increasing interest rates or stable economic growth? As shown with my econometric model, commercial banks in the U.S. have historically benefited greater from economic growth, in the current market environment, as opposed to an increase in interest rates. I use time series data on all commercial banks in the U.S. (consolidated), and an ARIMA model with additional independent variables, to support my conclusions. I also ran separate regressions based on bank size, and it is found that the performance of ‘large’ commercial banks (>$1B in total assets) benefits greater from economic activity (growth), when compared to smaller more regionalized banks. To truly maximize bank performance in the long run, interest rates should be determined based on a supply/demand equilibrium; which in theory should support stable economic activity.

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