Rate cuts will initially be a credit negative for most U.S. banks, Moody’s Ratings said.

The Federal Reserve’s expected interest rate cut later this week could create new challenges — and opportunities — for banks over the coming months.

Rate cuts will initially be a credit negative for most U.S. banks, according to a Monday note from Moody’s Ratings. The ratings agency expects deposit costs to reprice downward more slowly than loan yields, which will constrain net interest income (NII) — most banks’ largest revenue source.

In the long term, however, lower deposit costs should strengthen net interest income and continued economic growth will help maintain and improve banks’ asset quality, Moody’s said.

The Federal Open Market Committee (FOMC) is expected to carry out between a 25-basis-point and 50-basis-point cut Wednesday, following its September meeting. This would be the first rate cut since the central bank launched its rate-hiking campaign between March 2022 and July 2023, which has brought interest rates to 23-year-highs of 5.25%-5.5%.

Banks have been preparing for lower NII heading towards the end of this year and into 2025. Daniel Pinto, president of JPMorgan Chase, the largest U.S. bank by assets, said last week that its previous NII outlook for 2025 of $90 billion is “a bit too high.”

Laurent Birade, Moody’s Banking Industry Practice Lead, said in a separate statement that banks can safeguard their margins by diversifying revenue streams and readjusting their interest rate frameworks.

“Facing the Federal Reserve’s potential rate cut of 25 to 50 basis points later this month, U.S. banks stand at a crossroads of challenge and opportunity,” Birade said. “This critical juncture offers banks a chance to reshape their strategies amidst the ebb and flow of economic policy.”

Lower rates will help boost bank equity, however, Wells Fargo banking analyst Mike Mayo said. A decline in rates could boost bank equity by an estimated 7% quarter-to-date, according to Mayo.

In the past, when the Fed has cut interest rates and economic indicators haven’t pointed to a recession, bank stocks have outperformed each time, Mayo said.

Researchers at Goldman Sachs see a higher likelihood of a 25 basis-point decrease, which would bring interest rates down to 5%-5.25%, but they “are admittedly uncertain about this,” they wrote in a note. Goldman is expecting three interest rate cuts this year in September, November, and December. By the end of 2024, rates could be between 75 and 100 basis points lower, according to Goldman.

Moody’s expects rates to decline by 200 basis points by the end of 2025 and sit at 3.25%-3.5%.

The current banking environment shows that many clients are holding off on investments and taking out loans as they wait for the start of the rate-cutting cycle. A Bank of America Securities analysis of recent updates from more than 30 bank management teams found that loan demand has been “non-existent” as clients wait for macroeconomic clarity following the FOMC meeting. Investment banking has also taken a hit as a result.

Meanwhile, credit quality is “hanging-in” as expected with rate relief on the way and assuming the job market continues to hold up, the researchers said.

BofA also said rate cuts won’t be a universal net negative on net interest margins, given that banks are better prepared and higher-for-longer rates have provided funding cushions, giving banks added flexibility.

The bank’s strategy team likened the volatile trading environment, driven by the rate cuts, recession fears, and the U.S. presidential election, to the scene in “Die Hard” in which Bruce Willis has to walk barefoot over shattered glass.