Monday, April 7, 2014

More bank balance sheet stuff

Here are a couple more graphs regarding bank balance sheets.  The first one shows both monthly and weekly levels in Loans & Leases in Bank Credit, which includes commercial credit, real estate credit, and consumer credit.  The recent sharp uptick is clear, and the weekly indicator confirms that this new level of growth should continue in the monthly data at least through March and April.  (The jump in 2010 is due to an accounting change.)

However, the second graph shows the longer term trend.  There is a very stable exponential growth rate until 2008, which then flatlined.  This new level of growth is not exceptional.  In fact, this is the minimum we need to expect in order for economic growth to remain strong coming out of QE3.

The third graph compares annual rates of growth in bank loans and leases.  The YOY growth rate in periods of economic expansion is always between about 5% and 12%.  That would correspond to a growth in L&L assets of $30 to $80 billion a month at current levels (or $7 to $18 billion a week).  The growth level in the 12 weeks since Jan. 1 has been about $11 billion per week.  So, as extraordinary as this appears compared to recent bank expansion, this is not much more than the minimum we need to see for typical growth.  Of course, we are only halfway through the taper, so maybe we can expect this to continue to accelerate.

Next, is a graph comparing the level of securities in bank credit (low risk securities like Treasuries & Agency debt) to total bank assets (minus cash), commercial & industrial loans, and real estate loans.  There is a clear cyclical pattern in which banks increase the level of credit risk (through C&I and RE loans) during recovery periods and increase the level of low risk securities (treasuries and agency debt) during downturns.  In the great moderation period, these indicators have all bottomed at about the same time, and the initial cyclical increase in short term interest rates has coincided with those bottoms.  During the current cycle, however, C&I Loans bottomed in late 2010 while real estate and total assets, as a proportion of govt. securities, leveled out in early 2013.

This is probably related to QE.  I think we can look at QE from the Federal Reserve as a substitute commercial bank that limits itself only to Securities in Bank Credit.  Here is what these proportions of bank assets look like if we include the QE assets and QE related reserves as part of the ratios.  Here, all the proportions are still declining.  I think we should expect them to turn around with the end of QE3.  The commercial banks might rebuild their stock of Securities in Bank Credit initially, which might keep these ratios near the current bottoms.  But, if there is some causality in the direction from bank asset levels to interest rate levels, then when we see these proportions start to climb again, there should be pressure on short term interest rates to also increase.

Also, while there has been some substitution of funding for real estate and corporate loans outside the banks, evidenced by the increase of all-cash real estate purchases and loan funds with non-bank funding, the net effect of QE was probably still to concentrate more capital in govt. securities instead of corporate or real estate credit.  This might be why corporate credit spreads have remained unusually high and are just now falling toward typical recovery levels as QE is tapered.

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