Why did banks cut back on lending after QE?

Discussion in 'Economics' started by vashp2029, Feb 17, 2018.

  1. vashp2029


    I know that there were changes placed on banks with respect to liquidity coverage ratios and reserve ratios, but with the influx of cash through QE, why has lending been reduced by banks, especially considering short-term interest rates near the zero bound for the majority of the past decade?

    Every article I find online sites the reason as being lack of creditworthyness of the consumer, but that's rarely stopped banks from lending so I see a cognitive dissonance when someone uses that as the reason for lack of lending. There has to be some benefit to banks in keeping excess reserves at the Fed, what could that be? Is there some fundamental flaw in the way I'm thinking about how QE impacted bank balance sheets?
  2. Regulation is the main reason...
    piezoe likes this.
  3. DeltaRisk


    A lot of it has to do with the open window and repo market. They’d rather take zero risk than a risk on a consumer, that only applies to the primary dealers though.
  4. vashp2029


    Can you go into more detail about the repo market? I tried to understand it back when I read "When Genius Failed" but I still feel like I don't understand it completely. What is its purpose?

    Jeffrey Sneider talks about how big the repo market is in his interviews on MacroVoices podcast which got me interested again but I couldn't keep up. If the repo market is about borrowing/lending treasuries as collateral, wouldn't QE have forced the market to reduce in size by buying up a large portion of the treasuries?

    Also, what changed from pre-2008 to post-2008 that would make the repo market more attractive than consumer lending? I suppose you could say this is where the creditworthyness of consumers comes into play, but surely that has improved since the recession, yet lending is still anemic.
  5. The answer to your question has nothing to do with the repo mkt...

    It's all rather simple.
    piezoe likes this.
  6. s0mmi


    The answer to the question is quite simple;

    The whole reason that QE was done in the first place was to inject money, confidence, semen, straight into the economy because the U.S. was on its knees and credit was not flowing around like it should in a healthy economy (the GFC was really deep).

    When they started printing money, the banks first looked after themselves by taking the free money by the Fed (0% interest almost) and lent it out to super safe businesses at their rate. They remembered the GFC too well, and didn't want to just immediately go back into giving loans because they were butthurt after 2004-2006 lending practices.

    Now that its been a number of years, and the unemployment rate is down along with GDP consistently tugging 2%, the loan rate started to increase.

    Imagine you were a drug dealer kid and your parents gave you $50,000 cash for Christmas. You'd temporarily stop dealing. But eventually, when the money started to wear away, you introduce it back into your routine, but you don't need to do the amount of runs you were doing before the Christmas gift.. until eventually, you run out of Cash, and the cycle repeats...
    Van_der_Voort_4 likes this.
  7. People get rich more and more.People should stay poor.
  8. Hotcakes


    Please explain more?
  9. It's rather eloquently explained by @s0mmi (although I ain't too sure abt the "semen" bit).

    It's natural, for a whole variety of reasons, for both the supply of and demand for credit to diminish after a pretty significant financial crisis. Yes, of course QE was an attempt to offset this, but the problem was larger than the Fed. That situation slowly healed itself over time, as balance sheets were slowly repaired.

    Furthermore, as I said previously, bank regulation that came into effect post-crisis played a role, since it effectively made it more attractive and reasonable for banks (especially, large ones) to hold excess reserves at the Fed, relative to other alternatives.
  10. piezoe


    I wouldn't pay much attention to a few of the responses here. Martinghoul, on the other hand, has given you correct information. Immediately after the financial crisis we were of course entering a deep recession: "the great recession." Issuing of new credit naturally declines during recessions. People are losing jobs, losing homes to foreclosure, and businesses are uncertain about the future.

    Mark to market accounting is used each day to compute a banks assets and liabilities. When the crisis hit, collateralized debt obligations, known as CDOs, became illiquid. It became virtually impossible to establish a value for them based on market value. The CDOs were not worthless however. The Central Bank stepped in, did their own evaluation using their own formula, and bought them from the banks at a discount. Once the banks' illiquid assets had been converted to cash deposits in their reserve accounts at the Fed, most banks could satisfy their solvency requirement via mark to market accounting. (Of course many banks did go under and were subjected to FDIC Resolution. Banks don't go bankrupt! They undergo "resolution". )

    Normally the Fed will only buy Treasuries, but they made an exception during the crisis and bought CDOs too. When the Fed buys bonds, no matter who they buy them from, bank reserve accounts end up being credited because these are the accounts that day to day financial transactions pass through. The large transfer of non-cash assets from banks to the Fed in exchange for cash resulted in bank reserve accounts growing. Normally, the Fed would counter reserve account growth by selling bonds. However, in this instance, the Fed intentionally began a program of bond buying (QE). This caused reserve accounts to keep on growing well beyond their minimum required amounts. This in turn resulted in the Fed Funds rate dropping rapidly toward zero! (This was exactly what the Fed intended. ) The Fed also instituted operation "twist" in which they sold shorter term bonds and bought the 30 year, or "long", bond . Since mortgage rates key off the 30 year, the twist brought mortgage rates down and caused variable rate loans to reset lower rather than higher. This helped millions of troubled home owners to stay in their homes.

    At the same time bank reserve accounts were swelling, bank customers for new loans were drying up. There were too few borrowers to keep up with the rate at which reserve accounts were growing, despite very low interest rates.* (Contrary to the impression left by the way Macro Economics is taught, just making lots of money available at low interest rates is not a very effective tool, by itself, for bringing a country out of recession.) To keep the funds rate from actually dropping to zero the Fed decided to begin paying a small amount of interest on reserve accounts (they normally don't). This put a floor under rates. (As far as I know the reserve requirement was never altered during QE. Instead, it was the Fed that abandoned their normal practice of draining excess reserves by selling bonds -- they bought instead. The Fed's bond buying caused reserve balances to grow and the funds rate to fall rapidly toward zero.)

    So to answer your question in still another way, during QE, borrowing decreased not because banks wouldn't lend to credit worthy borrowers, but rather because demand for loans dried up. The Banks had plenty of money (they always do, regardless) and they had very favorable terms (they don't always). What they did not have was enough takers. We were in the midst of the Great Recession.

    Then enter Dodd Frank. Now lending standards have tightened up, and there is a myriad of new red tape and additional cost to borrowing, as anyone who has gotten a loan recently can testify to.

    *Regardless of how much money is in reserve accounts, the amount is never a restriction on lending. Controlling the aggregate reserve balance at a fixed value is strictly used, under normal operation, as a mechanism for holding the funds rate level and never for the purpose of restricting the amount of money available for lending. It is perhaps of interest that Central banks do not have to have a mandated minimum reserve balance at all to be able to control the wholesale cost of money. There are alternate related mechanisms practiced by other central banks that seem to work as well, Canada's Central Bank may be one, not sure.
    Last edited: Feb 19, 2018
    #10     Feb 19, 2018