2013-11-24

More Evidence of Deflation: Banks Could Charge Depositors

Deposits are unsecured loans to the bank. Your deposits in a bank are not your money, the money belongs to the bank and you get repaid so long as the bank remains solvent. In the event the bank fails (and there's no deposit insurance or it is inadequate), you get paid after other senior creditors are repaid first.

The banking system is powered by lending, not deposits, and it is by lending (and fees) that banks make money. I explained this in some detail in State of play in Q32012: Fed and U.S. government policy is not enough to offset deflation. The part titled "Credit creation is driven by borrowers, not bankers" discusses the banking system.

Currently the Federal Reserve is paying banks on their excess reserves. These reserves can be bank assets (the bank's own cash) or bank liabilities (money they owe the depositors); it is cash the bank has not loaned out. If that money ultimately belongs to depositors, then excess reserves collecting interest at the Fed can be passed along to individual depositors with their own "excess reserves" in, say, checking accounts. Without that income stream, however, banks will view those deposits solely as a cost, unless they're collecting fees on the account, because they're unable to earn profits by lending.

US banks warn Fed interest cut could force them to charge depositors
Executives at two of the top five US banks said a cut in the 0.25 per cent rate of interest on the $2.4tn in reserves they hold at the Fed would lead them to pass on the cost to depositors.

Banks say they may have to charge because taking in deposits is not free: they have to pay premiums of a few basis points to a US government insurance programme.

“Right now you can at least break even from a revenue perspective,” said one executive, adding that a rate cut by the Fed “would turn it into negative revenue – banks would be disincentivised to take deposits and potentially charge for them”.

Other bankers said that a move to negative rates would not only trim margins but could backfire for banks and the system as a whole, as it would incentivise treasury managers to find higher-yielding, riskier assets.

“It’s not as if we are suddenly going to start lending to [small and medium-sized enterprises],” said one. “There really isn’t the level of demand, so the danger is that banks are pushed into riskier assets to find yield.”
No great demand for loans! Since lending makes the money supply go round, a lack of lending means a lack of inflation. Yes, the Fed is monetizing debt, but it is only turning credit money into base money, it is not expanding the total supply of money and credit through this operation. It is transforming credit into money in the hopes that this will spur more lending. Bank lending is the engine of the financial system train, not the caboose!

I won't touch the comment about banks buying riskier assets, only to say that the words "crack up boom" and "bubble" come to mind.

From 2010: In Cash Glut, Banks Try to Discourage New Deposits
From 2011: Why Many Banks Don’t Want Your Money

Banks don’t lend money
I shall finish with a quote form Professor Victoria Chick, Emeritus Professor of Economics, University College London: “Banks do not lend money. It may feel like it when you get a ‘loan’, but that’s not what they are doing. They don’t have a pot of money which they are passing on. What they are doing is accepting your IOU… they simply write up your account”.

This discussion goes more in depth: Monetarism Unplugged
Banks run complex money market operations to respond to the net movements in their reserve accounts that result from asset-liability transaction activity in the rest of the organization, including the main loan and deposit book. (Those flows include voluminous amounts of deposits shifting between banks, without any necessary connection to new loan extensions. Such activity results simply from the ongoing use of existing bank money in regular economic activity. It is inherent in the concept of money “velocity”.) Banks adjust their reserve accounts in response to these effects through offsetting transactions in short-term liquid assets and wholesale deposit liabilities. These money market operations are the balance wheel for reserve account disruptions caused by net flows through the main loan and retail deposit banking operations. Effectively, changes in reserve balances that are the result of client initiated activity in loans and deposits are offset by reversing changes in reserve balances initiated in wholesale money markets by the bank itself.

(Note that in today’s environment of chronic system excess reserves, individual banks with outsized excess reserve positions may simply let those balances decline in response to a net reserve outflow. That is a special case of a bank using the ultimate liquid asset (excess reserves) to absorb a net reserve outflow. When a bank already holds excess reserves, those reserves can be viewed as such a liquid asset that is “sold”, in effect, in order to meet a net reserve outflow. If the bank did not hold excess reserves already, it might sell a more conventional liquid asset such as treasury bills for example, in order to offset the net outflow of reserves that occurs otherwise.

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