Taps Coogan – July 16th, 2021

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Chris Whalen, Whalen Global Advisors Chairman and author of The Institutional Risk Analyst, recently spoke with BNN Bloomberg about this quarter’s bank earnings announcements and how they shed light on why bank lending relative to deposits is at a 30 year low. The interview hits on themes we’ve been covering since day one on this site, namely that the Fed’s post-Financial Crisis policies of zero interest rates, large QE programs, and paying interest on excess reserves are actually dis-incentivizing bank lending.

Some excerpts from Christopher Whalen:

“The first quarter was probably the best quarter for the industry (banking industry). They are, once again, facing the Federal Reserve pushing down interest rates and also compressing spreads, which is how banks make money. So for big banks they are battling to retain assets (TC: assets are loans for banks) and retain size. It’s hard for them to originate and retain loans in this environment because rates are so low.”

“Until the Fed really shifts policy and allows rates and also spreads, the difference between different bonds and loans pricing…, to expand, it’s going to be hard for banks to make money. It’s also hard for other savers to make money… I think this is a more general problem which is the economist class has run out of options, they’ve run out of ideas… We’ve turned Fed Fund in the US into a government market. There are no private parties trading Fed Funds because the Fed has taken it over and I worry about this because the more we take away price discovery and the more we nationalize our markets in the US, the less resilience we’ll have going forward…”

“The payments (the Fed) makes on reserves also help the banks, but ultimately what the banks really want to do is make loans at reasonable prices and today when they look at some of the loans they can make, the pricing isn’t attractive so they fold their arms. We are at the 30 year low of loans as a percent of assets in the banking system. We’re also at a 20-plus year low in terms of net interest margin. So, the Board of Governors at the Fed, the FOMC, they need to be worried about this because by the end of the year, I think we could see another 20 basis points of contraction of net interest margin and that’s not good.”

“These big banks…, they turn over their assets every three to four years, which means they’ve got to go out and replace 25% of their (loan) book every year just to maintain their size…”

Here is a riddle. How are banks supposed to grow when the 16 to 65-year-old population is shrinking (the segment of the population that are net borrowers), interest rates are near zero and far below the inflation rate, and most of the credit growth is in government and corporate bonds held by investors not banks? 

Answer? By parking reserves at the Fed and collecting interest while taking zero risk and serving no useful economic function. 

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