Chart of the day, bank-lending edition

By Felix Salmon
September 17, 2013

Well done to Matt Levine for finding — and explaining very clearly — the BIS’s special feature, by Ben Cohen, on the way in which the world’s banks have adjusted to higher capital requirements. Basically, the BIS, which sets the Basel capital requirements for the world’s banks, wanted to know how banks reacted when those capital requirements were raised.

The first thing that happened is that the banks did, in fact, become significantly better capitalized — and that is especially true of what the BIS calls “large, internationally active banks”. Since those are the banks we’re mainly worried about, this is definitely good news. Those banks were well below the Basel III minimum at the beginning of 2010, but they reached it by mid-2011, and they comfortably exceeded it by mid-2012, well ahead of the Basel III schedule.

The banks achieved this feat in the most painless way possible: they simply retained their earnings, rather than paying them out in dividends. And those earnings weren’t easy to come by, either. The banks in general shed what Levine calls “income that lots of people find naughty, prop trading and so forth”, which reduced their overall profitability. The banks instead had to make money the old-fashioned way, by lending it out at a higher rate than their cost of funds. Net interest income, across all global banks, rose substantially from the pre-crisis period to the post-crisis period: it was 1.34% of assets in 2005-7, and 1.62% of assets in 2010-12.

Here’s where the slightly disappointing part of the story comes in, though: despite the fact that their loans were more profitable than ever, the banks didn’t actually lend more, overall. The BIS report has some rather confusing charts on this, so here’s a FRED chart I put together, showing total US bank credit, in constant 2008 dollars, over the past 15 years:

The story here is clear. Total credit was rising at a very steady real pace for the decade running up to the crisis — but then it stopped growing when the crisis hit, and it has never really recovered.

Levine, and the BIS, put a positive spin on this, saying that the banks “are not cutting back on lending”. Which is true — but they’re not exactly fueling the recovery, either. Indeed, this chart is worse than what we would have seen if the banks had just rolled over all their existing loans and made no new loans at all.

That said, I’m not sure that this chart is really bad news. If you stipulate that there was too much lending in the economy in 2008, and that we needed to enter a period of slow deleveraging, this is actually exactly what the doctor ordered.

One way of reading the BIS report is to think of a set of trade-offs between three constituencies: banks, borrowers, and regulators. When the regulators got tough and implemented Basel III, the main losers were the banks, which lost a lot of permanent profitability. But borrowers were also hit: they’re paying more for loans, and they’re not being given as many loans as they were in the past. The big winner, meanwhile, was society as a whole, which significantly reduced the amount of systemic risk in the banking system.

The BIS is not entirely unsympathetic to the banks. In fact, in a quite astonishing passage which Levine picks up on in a footnote, they suggest that maybe the banks could form an informal cartel, passively agreeing not to compete with each other on lending rates:

The bank could seek to reduce the share of its profit it pays out in dividends. Alternatively, it may try to boost profits themselves. The most direct way to do so would be by increasing the spread between the interest rates it charges for loans and those it pays on its funding. While competitive pressures may limit how much an individual bank can widen these spreads, lending spreads could rise across the system if all banks followed a similar strategy and alternative funding channels (such as capital markets) did not offer more attractive rates.

Remember that from a regulatory perspective, a highly profitable bank is a significantly better bet than one with narrower profit margins. Regulators want banks to make good money: it makes their own job a great deal easier. And if that comes from charging borrowers higher rates, so be it.

What’s more, banks actually have the ability to do this relatively easily. Borrowers who don’t have direct access to the capital markets — which is the overwhelming majority of us — are not, in reality, particularly price-sensitive when it comes to lending rates. Payday lenders learned this lesson years ago: borrowers value convenience much more than they do lower interest rates. And as a result, banks actually have quite a lot of leeway to raise lending rates if they want to, at least when it comes to individuals and small businesses.

And in reality, a large part of the stagnation in bank lending has to be a consequence of the fact that the economy as a whole is evincing little demand for credit. Individuals are more interested in paying down their debts than they are in borrowing more; businesses, too, have learned the hard way that debt has a tendency to bite, hard, at the worst possible moment. If higher lending spreads help to discourage borrowing, at the margin — and maybe conversely encourage businesses to take some kind of equity funding, instead — then possibly they will result in a more resilient economy overall.

For the time being, as well, higher bank spreads are no big deal, just because the banks have such an incredibly low cost of funds: the actual nominal interest rates being paid by borrowers are still extremely low. My own bank recently offered me, out of the blue, a free, unsecured credit line at 6.3%: that’s well above their cost of funds, but it’s still a very low interest rate, in the grand scheme of things, should I find myself in a position where I need to take advantage of it.

So I’m with Levine on this one: so far at least, Basel III seems to be working in an almost optimal manner. We’re used to a world where the only way you can achieve growth is through leverage — and we learned, with extreme pain, that leverage is a very dangerous thing. This recovery, by contrast, is not being driven by leverage. And that is surely a good thing.


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Banks are cutting back on lending. It looks like lending is where it was at 5 years ago, but lots of profitable companies are borrowing at very low cost, often because they don’t want to pay taxes on foreign profits, or just because it’s very cheap. The recovery is not being driven by leverage, but that’s only because there isn’t a real recovery.

If you believe those who say its okay for companies and individuals to accumulate (a euphemism for hoard) profits, because those profits will get lent out to finance new ventures and investment, then leverage is necessary for recovery. Which is why unemployment is still too high for those who can’t find jobs. Not enough profits have been re-injected into the economy in the form of dividends, loans, or higher individual income for workers that would be spending all of their paycheck, instead of hoarding even more.

Posted by KenG_CA | Report as abusive

Can you explain the thought process whereby banks can charge higher rates with no consequences? What is a bank competing on, for the average middle-class borrower, other than price? Service is the same, some banks have slightly more/less diligent underwriting standards, but to most consumers who borrow relatively large sums infrequently, price is the only difference between bank A and bank B.

As rates rise, it seems to be that losing out on loans is going to become more painful, in the sense that the biggest loans out there – mortgages – are going to become less common due to less people refinancing into lower rates. I think I saw recently that 9 years is the average period for owning a home, so you’re talking about having access to a prospective “large loan” customer once per decade going forward.

Posted by Harpstein1 | Report as abusive

I am also confused. Why do you expect borrowers to start borrowing more, even while banks are raising their rates? Is this ‘rational’? Or are you only concerned with the PoV of the banks/”macro policy”?
Secondarily, a lot of loans still have to be written off because they’re basically zombie loans to insolvent debtors, even while the BIS is using the mark-to-make-believe values as the ones that accurately reflect bank capital levels… iow, the data is rather tainted.

Posted by Foppe | Report as abusive

Sounds like a vindication for ‘public choice’ theorists. After all, the BIS is acting just as government agencies are generally inclined to do according to such theorists: it is encouraging the cartelization of those it regulates. “Oh, yes, we want you to make nice big safe profit margins, so why don’t you all mute any competitive voices in your ranks.”

Once the central bankers of the world have decided that some of the sheep in their care are too wooly to fail, the next step is logically and necessarily to protect them from even the hint of a threat of failure: to keep them fat and happy.

None of this is good for the economy but, hey, the public choice guys have long warned us it wouldn’t be.

Posted by Christofurio | Report as abusive

Banks also made a lot of money originating mortgages that were eventually bought by GSEs. That is not “lending it out at a higher rate than their cost of funds.” You would expect net interest income to rise in a period of decreasing rates, but as more and more loans are re-financed, and “risk-free” rates rise, that can go away. A big thing to analyze is the impact of the rapidly slowing re-fi rate, and the drying up of the origination income stream for banks.

Posted by winstongator | Report as abusive

What’s the downside? I don’t know – what was the downside of the easy money bubble or the subprime/CDS easy money bubble? You are an inspiring figure Mr. Salmon – don’t know a damn thing about something as basic as this, yet hired on by a major news organization to write a financial blog. Keep up the good work, you may be plucky and ignorant enough to be a Federal Reserve Chairman someday.

Posted by PianoRoll | Report as abusive