What happened
If you follow the stock market (or the news at all), it's no secret that the past week hasn't been a good one for stocks. As of 12:30 p.m. EST on Friday, the Dow Jones Industrial Average and S&P 500 are down by 14% and 13%, respectively, for this week alone.
However, some areas of the market are getting hit even harder. Many bank stocks have done even worse than the overall market. Sector heavyweight JPMorgan Chase (JPM 0.49%) is down by 15% for the week and by 5% on Friday alone. Bank of America (BAC -0.13%) has fared even worse, with a plunge of more than 17%. Most other major U.S. banks are in the same boat.
Image source: Getty Images.
So what
To understand why bank stocks are performing so poorly, it's important to take a step back and understand how banks make their money. While there are many possible revenue streams, most banks still make the bulk of their money from interest income -- that is, borrowing money at a low interest rate and lending that money out to customers at a higher rate.
For example, let's say that a bank pays 1% interest (APY) on its deposit accounts and charges an average interest rate (APR) of 4% on loans. The difference, or 3%, would be the bank's interest margin.
This week, interest rates -- specifically Treasury yields -- have plunged to all-time lows. Lower interest rates generally lead to lower interest margins for banks.
Some banks are more susceptible than others. Bank of America, for example, has a high concentration of non-interest-bearing deposits relative to its peers, so its margins get squeezed more than most when rates drop.
Now what
Of course, there are other ways banks make money. Many big banks also have an investment banking division, for example. Consumer banks also make money through various fees for their services, such as loan origination fees, account maintenance fees, wire transfer fees, and more. However, profiting from lending money is still the main profit source for most banks. That's why the plunge in interest rates has hit bank stocks like JPMorgan Chase and Bank of America so hard.
