Can government get banks lending?

By Felix Salmon
March 1, 2010
Daniel Davies's short post about how difficult it is for a government or central bank to get banks lending again:

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In 2001, after the 9/11 attacks, former U.S. President George W. Bush signed into law a $15 billion airline bailout, and I remember reading (I can’t find it now) a cogent argument that it really didn’t make much sense, since the airline business was reasonably competitive.

If any given airline was solvent, then throwing money at it would be unlikely to change the mathematics of any decision as to whether or not to invest money in new planes or flights. And throwing money at an insolvent airline just ends up bailing out creditors and shareholders, and makes it harder for younger, nimbler competitors to enter the market.

I was reminded of that argument when I saw Daniel Davies’s short post about how difficult it is for a government or central bank to get banks lending again:

Banks make loans and then work out how to fund them, they don’t raise deposits and then work out how to lend them. Therefore there basically is no “credit channel” of monetary policy; bank lending is exogenous (or rather, it’s exogenous to the monetary policy regime; it’s determined to a significant extent by overall macroeconomic conditions but not in a straightforward or easily analysable way).

This is a little bit of an oversimplification: if you read the BIS working paper that Davies is referring to here, it makes clear that monetary policy has little if any effect on bank lending if and only if the banking system is adequately capitalized. Monetary policy can have an effect on lending insofar as cutting interest rates helps to steepen the yield curve and thereby improve the financial health of the banking system, which generally borrows short and lends long.

But the central insight is undoubtedly true: the size of a bank’s deposit base is not a meaningful constraint on the amount of lending it does. And what’s more, if you have an adequately-capitalized bank, like say JP Morgan Chase, then throwing money at it either through fiscal policy (Troubled Asset Relief Program) or through monetary policy (cutting interest rates) is by no means guaranteed to change the amount of lending that the bank engages in.

If you want to get banks lending again, governments can try a bit of moral suasion, but ultimately it’s a decision that any bank is going to have to make on its own economic merits. And it’s likely, unfortunately, to take rather more time than most governments — and borrowers, for that matter — have patience for.

Oh, and one other thing: when the government guarantees loans, for instance through the Small Business Administration, that might do more to help increase lending — but only by transferring credit risk out of the banking sector and onto the taxpayer. And it might in fact just move lending activity into the small-business area from elsewhere in the bank, without increasing the total amount of credit that the bank makes available. It would be great to see some empirical studies on such matters.

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