Banks need to guard against short-term debt creep

April 14, 2011

By Agnes T. Crane
The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

NEW YORK — Borrowing short and lending long is the essence of banking. But the business model has some serious flaws when big banks dive too deeply into short-term debt, as they did before the 2008 financial crisis. There’s little danger yet that bad habits have returned, but recent data indicate some banks may be flirting with temptation.

Banks — in the United States and UK in particular — have made serious headway in reducing their reliance on debt markets in the past two years. They’ve also worked to stretch out the time they have to pay creditors back. Moody’s calls the progress significant, with debt profiles heading back toward a more normal six to seven years rather than the alarming 4.7 years on average globally and 3.2 years in the United States seen in 2009.

Banks will still need to roll over or pay back $3.6 trillion over the next two years, however, according to the IMF. As long as credit markets remain on cruise control this shouldn’t be a problem. Even if turbulence strikes, banks in the United States, for example, count on a fat cushion of deposits to soften the blow.

But quiescent capital markets may be emboldening some to creep back into shorter-term debt. In the first three months of this year, a third of the $51 billion borrowed by America’s biggest and most systemically important banks in the corporate debt market matured in three years or less, according to Thomson Reuters, up from 15 percent a year ago. Commercial paper borrowing is also on the rise, up 11 percent in 2011.

Some of the change could be the result of the Federal Deposit Insurance Corp’s efforts to curb borrowing in the repo market, where financing can be as short as one day. Maturing bonds issued during the crisis, and guaranteed by the FDIC, could also be causing an outsized spike as banks refinance them with bonds of maturities below three years.

Still, borrowing patterns bear watching to make sure a creep doesn’t become a slide. The allure is powerful. Borrowing $1 billion for one year would cost a bank like JPMorgan <JPM.N> just $6 million over 12 months where a 10-year bond would cost around $47 million.

As long as short-term interest rates are rock bottom and credit markets stay friendly, the incentive to keep maturities shorter will be a little too tempting.

Comments

Why don’t you write about that the Fed has put options on treasury sales.

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