Did you know? Endowment effect

In banking jargon, the endowment effect is the profit tailwind that banks enjoy when central banks raise interest rates. At first blush, the concept is counterintuitive. We all understand that high interest rates eventually lead to rising defaults on home loans and credit cards, which is negative for bank profits.

But picture a bakery that suddenly raises the price of its loaves: every extra rand goes straight into profit if its flour cost stays the same. Banks enjoy a similar windfall when interest rates climb. Lending rates (on mortgages, vehicle finance and overdrafts) move up almost overnight, but the rate the bank pays on current account deposits hardly budges. That widening gap is called the endowment effect: an ‘unearned’ boost to profit margins that feels like finding money down the back of the sofa.

The effect works both ways. As soon as policymakers cut interest rates, competition forces lending rates to drop immediately. However, banks are often slower to cut deposit rates for fear of sparking a run on deposits — if they paid anything to start with. The margin cushion deflates, profit growth slows and share prices often follow. For investors, the key takeaway is timing: bank earnings often peak after the peak in rates.