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Banks Doing Too Much, Too Little Lending

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One lazy but fun thing to do as a financial blogger is to find two publications saying the opposite thing on the same day, and then be all "haha, dopes." Business Loans Flood the Market, the Journal informed us this morning, while Bloomberg tells us that by another measure loans are at a five-year low, though being Bloomberg the way they put it is JPMorgan Leads U.S. Banks Lending Least of Deposits in 5 Years. So is there a flood of loans, or a least of loans? Which is it, guys?

Well, both, obviously; "haha, dopes" would not be fair here. Loans are up, relative to the last couple of years, but loans as a percentage of deposits are at a low - 84% for the top 8 commercial banks, per Bloomberg, as opposed to 101% in 2007. Bloomberg acknowledges this tension:

Falling ratios don’t mean banks have shut the lending spigots. Measured in dollars, total loans rose in the fourth quarter for the biggest eight lenders to $3.9 trillion.

As does the Journal, which notes that "The push comes at a time when many banks have been flooded with deposits as slow economic growth and low interest rates crimp investment."

The way I think about banks is that they do two somewhat separate things, which are:

  • satisfy some people's demand for money claims (short-term, safe, exchangeable-for-fixed-amount-of-cash bank liabilities),1 and
  • satisfy other people's demand for loans.

It's not entirely obvious why those things would move in lockstep: why should the quantity of loans demanded by borrowers be a fixed percentage2 of the quantity of deposits demanded by savers? The traditional answer is that prices clear markets, and that the interest-rate curve is the price (set of prices really) that balances demand for loans with demand for deposits.3 A more in-depth answer adds consideration of not-quite-price-but-still-price-ish terms, like credit standards and covenants. Price and other adjustable terms adjust until the market clears.

The Journal is worried that banks are adjusting too far:

The surge in loans to businesses is raising worries that lenders are competing so aggressively that some will pay for their largess down the road. ... Yet the profitability of the loans that banks are making is under pressure.

More than half of banks surveyed in the quarterly Federal Reserve survey of loan officers said that lending spreads—a rough gauge of profit that measures the gap between the rates at which a bank borrows money and lends it out—had narrowed in the past three months. The survey said standards on loans to medium and large firms eased for the fourth quarter in a row. Respondents "cited more-aggressive competition," the Fed said.

[FBR analyst Paul] Miller said lenders are learning they must in many cases "let deals walk" because terms are becoming too risky.

But despite banks' flexibility on both price and risk, the market isn't exactly clearing, according to Bloomberg and the promiscuous Paul Miller:

“You’ve got to see sustainable economic activity before lending picks up,” said Paul Miller, an analyst who follows the industry at FBR Capital Markets Corp. Until then, banks will be stuck with idle cash, Miller said. “There’s no place for them to put it.”

I mean obviously there's some place for them to put it. Chief Investment Offices or whatever. Some of those things are sort of like lending, and some aren't. Some are in a weird netherworld; is buying agency RMBS and writing protection on CDX more like lending, or more like not lending?

One thing that a lot of people want to do is reduce the percentage of bank assets that are funded by money claims. We talked a week ago about proposals to make banks do a lot more funding - say 15% of assets - via long-term debt, and those and similar proposals seem to be moving forward. And Anat Admati and Martin Hellwig have been getting a lot of press for their theory, propounded in their new book, that banks should just have way way way more equity capital than they have now. 25% of assets, say, as opposed to the 3-to-10-ish-percent-depending-how-you-count that is standard for big banks these days.

Much of the discussion of these ideas is devoted to proving that higher capital requirements wouldn't reduce lending, and, I mean, sure. I think that today's articles amply support that: lending is flooding! Idle cash! Whatever. Raising more cash wouldn't lead to less lending.

But neither would it lead to more lending, right? Lending is about as floody as it can be, says the Journal, but still not floody enough, says Bloomberg. And so more capital would put pressure on the money-claim side of things. Bank equity and long-term debt are not, for their holders, good substitutes for money-claims; if you want a short-term cash-like place to put your money, buying Bank of America stock won't really satisfy that desire. If right now banks are, like, 15% long-term funded, and new proposals would make them like 30% long-term funded, and if they kind of can't increase loan assets because there's no one to lend to, then ... well then what?

One option is that banks keep the same amount of money-claim, short-term funding, and just gross themselves up. If you're now a $2trn bank with $300bn of long-term funding (equity and long-term debt) and $1.7trn of deposits etc., you become a $2.43trn bank with $730bn of long-term funding and a constant $.17trn of deposits etc. So you buy an extra $430bn of trading assets. That could work, and even if those trading assets are riskier than your loans (and why would they be?) the extra capital cushion would still end up making you safer on net. I worry about the Volcker Rule, London Whale, internal-hedge-fund headlines, though. Banks are using your deposits to traaaaade!

The other option is that banks keep the same amount of assets, and reduce their short-term funding. So you become a $2trn bank with $600bn of long-term funding and $1.4trn of money claims. Where do the other $300bn go? Well, maybe prices clear markets, and they stop being "cash in the bank" and go into productive longer-term investments. But, again, today's articles might raise some doubts about that: the fact that loans are dropping as a percentage of deposits suggests that the demand for money claims exceeds the demand for productive loans.

So instead maybe those claims go into money market funds and asset-backed commercial paper conduits and repo markets and other highly leveraged shadow-bank-y things that provide money-claim-like liabilities but have the distinction of not being banks.4 And the further distinction of not being regulated like banks. And the even further distinction of being potentially even more destabilizing than banks. That seems to me like a not entirely positive consequence of some ideas to improve bank safety.

Business Loans Flood the Market [WSJ]
JPMorgan Leads U.S. Banks Lending Least of Deposits in 5 Years [Bloomberg]
The Real Problem with the Big Banks [New Yorker]
One consequence of better-capitalised banks [Free Exchange]

1.I sort of steal the money-claims idea from Morgan Ricks; we've discussed it a bit before. In the banking context I mean it to mean short-term/demand, good-as-cash liabilities, including deposits but also things like commercial paper, repo liabilities, etc.

2.I don't know what that percentage is; as noted above it's actually varied from ~84% to ~101% over the past few years. Here's Bloomberg:

“There really is no magic number,” [SNL Financial analyst Nancy] Bush said. “You just don’t want to see a bank over 100 percent,” which may indicate the bank is relying on outside sources for short-term funds to finance loans, Bush said.

I guess. Your basic schematic loans-and-deposits-only bank will have assets equal to ~111% of deposits (assuming it has 10% capital), and loans equal to [111 - X]% of deposits where X is whatever prudent amount of cash liquidity it should have.

3.Obviously I should be saying "demand for loans" and "supply of deposits" but: I'm not. Here I want to emphasize (1) that banks are operating in two conceptually distinct markets and (2) that in each of those markets there is a "demand" from customers who are coming to banks to solve their problems - "give me a loan" or "keep my money safe" - and the banks are sort of in a reactive and matching role.

4.Or maybe, as Matthew Klein suggests, they go into an increased supply of Treasury securities. I suspect "vast increase in government debt" would be a surprising outcome to at least some advocates of better capitalized banks, though.