What happened

Shares of large financial institutions underperformed during a miserable month for the markets, as investors braced for the impact of falling interest rates and a potential recession. Banks make their money based on the amount of interest they can charge when making loans, and in a slowing economy, earnings tend to get hit.

Citigroup (NYSE:C) shares fell 33.6% for the month, according to data provided by S&P Global Market Intelligence, while shares of Wells Fargo (NYSE:WFC), U.S. Bancorp (NYSE:USB), Bank of America (NYSE:BAC), and JP Morgan Chase (NYSE:JPM) were down 29.7%, 25.8%, 25.5%, and 22.5%, respectively.

So what

There was a lot going on in March with the world, and markets, focused on the COVID-19 coronavirus pandemic and its impact on society. But for bank investors, the pivotal moment came on March 15, when the Federal Open Market Committee slashed the benchmark federal funds rate by 100 basis points to a target range of 0% to 0.25%. The cut followed a 50-basis point rate cut just a few weeks prior.

A banker reaches across his desk to shake hands with customers.

Image source: Getty Images.

At their core, banks make their money on the difference between the interest rate they charge for loans and the interest rate they pay out on deposits. In a low-rate environment, both sides of that equation are squeezed down, making it hard for financial institutions to make outsized profits.

The reason for the Fed action was also weighing on bank investors. The government was reacting to a dramatic slowdown in economic activity due to the pandemic, which many fear will cause the U.S. economy to fall into a recession. During recessions, demand for loans tends to fall, and there are fewer borrowers able to make their payments, so more existing loans tend to fall into default.

Record jobless claims late in the month did little to quell investor anxiety.

Now what

The good news for banks is that they come into this in a relatively healthy position, and the Fed has made clear it will do what is necessary to keep financial systems up and running. What's happening now is much different than what happened in 2008 and 2009, a recession that was triggered by a financial crisis.

That said, even if the banks didn't cause the issues this time around, they are still going to be affected by them. We can say with some certainty the U.S. economy is either in a recession or soon will be. The question that remains is whether the slowdown will be short-lived or last well into 2021.

Expect the downward pressure to remain on bank shares at least until the pandemic is contained and we can begin to see how quickly the U.S. economy can recover. As reflected in the share declines, this is unlikely to be a quick process.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.