Commercial banking can be viewed as a fixed-income carry trade because banks typically engage in maturity transformation, where they borrow short-term and lend long-term.
* Short-term floating-rate deposits:
* Banks often attract deposits with short-term maturities and floating interest rates.
* These deposits are generally considered stable and low-cost sources of funds.
* Long-term fixed-rate loans:
* Banks use these short-term deposits to fund long-term loans, such as mortgages or business loans, which typically have fixed interest rates.
* This creates a mismatch between the interest rates and maturities of assets and liabilities.
* Carry trade analogy:
* The bank earns the spread between the interest it pays on short-term deposits and the interest it earns on long-term loans.
* This process is similar to a carry trade, where profits are derived from the difference between borrowing costs and investment returns.
Thus, commercial banking inherently involves aspects of a carry trade through the practice of borrowing short- term to lend long-term.
References
Source: How Finance Works