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Buy shares in these banks to profit from rising interest rates

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A Lloyds Banking Group Plc company logo above an ATM in Chelmsford
A Lloyds Banking Group Plc company logo above an ATM in Chelmsford

Investors who bet on the global banking sector have had a strong year.

The industry has delivered returns of 37pc in 2021, beating the MSCI World Index – which tracks the biggest companies globally – by 17 percentage points.

But investors could still find further profit in this industry. Thanks to persistently high inflation, global central banks are now on the verge of increasing interest rates.

William Howlett, of the wealth manager Quilter, explained: “Bank stocks would benefit from higher rates. This is because they can charge more on their loan products and boost their margins.

“We thought the Bank of England would raise rates earlier this month. But now we are all looking ahead to December, when there will be another meeting.”

Which banks are the best to own ahead of a possible rate rise? Telegraph Money speaks to the experts to find out.

Lloyds Bank

Sophie Lund-Yates, of the broker Hargreaves Lansdown, pointed to Lloyds Bank as a company that was undervalued by investors. “It is far more exposed to traditional lending than other banks, so if an interest rate rise comes down the pipe as expected, it would be even more beneficial,” she said.

Mr Howlett added that aside from the potential margin boost from a rise in interest rates, Lloyds offered an attractive underlying investment case. “It is a market leader across a range of products in Britain,” he said, pointing to its presence in mortgages and savings accounts.

The shares have climbed 35pc so far this year, but are still down 21pc from their 2020 high. “Most banks trade at a price-to-earnings multiple between seven and eight,'' Mr Howlett added, referencing a popular metric that indicates how expensive a company’s stock is relative to its profits. Lloyds currently trades at a price to earnings multiple of 8.

“This looks relatively cheap to us, but we think the discount will close soon if the Bank of England does raise the Bank Rate.”

NatWest

Nick Purves, who co-manages the £888m Temple Bar investment trust, highlighted NatWest as an option for investors.

“It has got a chequered past,” he admitted. “But it has massively simplified its business, and it has a significant amount of excess capital that it will be able to return to shareholders in the coming years.”

The stock has gained 42pc so far in 2021, but also trades below its 2020 high, lagging by 6pc. It was more expensive than Lloyds on a price-to-earnings basis, with a multiple of 11.

Barclays

Mr Howlett also flagged Barclays as a beneficiary of a rise in interest rates. The stock traded at a relatively low price-to-earnings ratio of six, but a robust recovery this year has meant the share price has already regained the ground it lost during the pandemic.

Ms Lund-Yates said Barclays derived less of its income from Britain and therefore its share price would not be as sensitive to a higher interest rate set by the Bank of England.

Darius McDermott of the fund shop Chelsea Financial added that investors could find these bank stocks in many funds with a “value” investment style.

He pointed to JO Hambro UK Dynamic and the Schroder Recovery fund, the latter's second biggest holding was in Barclays. He also tipped Jupiter UK Special Situations, which counted NatWest and Standard Chartered in its top ten investments.

But while high street brands have dominated the banking industry, Mr Howlett said there was increasing competition from younger start-ups.

For broader exposure to innovation in the sector, he suggested investors consider the Augmentum Fintech trust, which is invested in private companies such as the challenger bank Tide and cryptocurrency exchange Gemini.