U.S. Banking System Is Sitting on Its Hands

Jul.14.09 | About: Financial Select (XLF)

It’s time for another quick look at the United States banking system. Whoops! Nothing happening there. Are they still alive?

Federal Reserve Bank Credit has increased by $1.2 trillion over the past twelve months. What has increased in the banking system? Excess reserves in the commercial banking system have increased by about $800 billion. Tracing this “stuff” a little further, in round figures, the currency in circulation outside of the banking system has increased about $100 billion over the past year, about $100 billion has gone to foreign central banks in liquidity swaps, so there is another $200 or so in funds that the Fed has pumped into the system that is somewhere in Treasury accounts. But who is counting?

I am still concerned with what the United States banking system is doing with the money that has been pumped into it. The answer is, very little!

Looking at the H.8 release put out by the Federal Reserve System we see that the assets of all commercial banks in the United States have increased by 9.7% from May 2008 to May 2009, an increase of $1.1 trillion.

And what accounts for this increase in bank assets? Well, the cash assets of the banking system has increased a whopping $731 billion or at a year-over-year rate of 236%. This is comparable to the year-over-year increase in excess reserves observed on the H.3 release of the Federal Reserve.

Given my post of last June 15, 2009, “What Aren’t Banks Telling Us?”, I was interested in looking a little deeper into this information to see how these excess reserves were distributed within the banking system. The division is roughly this. The increase in cash assets at large commercial banks was $371billion, at small banks the increase was $143 billion, and at Foreign-related Institutions in the United States, $217 billion. The increase at the larger institutions, the large banks and the foreign-related institutions, was $588 billion.

The reason I am interested in looking into this distribution is the claim made in the above mentioned post that commercial banks had not been fully open with the public on the problems they were still facing. In that post I mentioned three areas of concern: the bad assets now on the books of the banks; the anticipated increase in the bad assets in the upcoming months; and finally, the needs of the banks to be able to fund themselves in the future in the face of liabilities that were maturing and would not be rolled over. The build up in cash assets, it was argued, was a precaution the banks were taking to handle the uncertainty they faced as either asset values fell or a run off of liabilities forced the banks to dispose of assets.

My interpretation of this distribution of cash assets in the banking system is that the larger depository institutions in the United States has stashed up almost $600 billion in preparation for an extremely bad scene. Why do I put this whole amount in this category? Because in the past the WHOLE banking system only kept about $2 billion in excess reserves and the banks we are talking about in this category are the most efficient and sophisticated banks in the world in terms of managing their cash reserves. So, excess reserves have gone from $2 billion in the WHOLE banking system to about $600 billion in the most sophisticated banks in the world!

Just to put this in perspective: $588 billion represents 7% of the total assets of the two groups that are counted in this category, large domestically chartered commercial banks and foreign-related institutions, both in the United States. The question is, can these banks really stand a 7% reduction in their balance sheets through charge offs or a run off of liabilities?

The situation is not so severe for the smaller banks in the report: cash assets totaled only 3.8 % of the total assets at these banks. Still, we are hearing more and more of the problems that the smaller banks are facing. For example, this week information was released that several smaller banks that had received TARP funds were not going to pay the dividend payments owed to the government. The health of the smaller banks has been something that has been off the radar screen given all the press that has gone to those banks that are “too big to fail.” We are going to hear more from this sector over the next several months.

The next question has to do with bank lending: are banks doing any lending these days? Year-over-year, loans and leases at all commercial banks increased by a tepid $182 billion or at a 2.6% annual rate.2.6% annual rate. And, where were these increases located? Generally in home equity loans and other residential loans (primarily mortgages). These were pretty evenly spread throughout the banking system.

Bottom line, however, is that the banks aren’t lending! Especially in the areas of commercial and industrial loans and commercial mortgages. Does that tell you something?

What can we take away from this?

The scary conclusion is this: Almost all of the Reserve Bank credit that the Federal Reserve has pumped into the banking system has gone to provide liquidity to the banking system for when the banking system implodes.

Commercial banks are not lending. Yet the banks are sitting on $800 billion of excess reserves. It is almost incomprehensible to me that the commercial banking system is doing nothing with these reserves! Unless…

No one is talking, not from the banking system, not from the Federal Reserve. What else are we to think at this time if we are not given any other information. We just have to think the worst!

-John Mason

Disclosure: This article was taken from Mase: Economics and Finance with the permission of the original author. All disclosure questions should be referred to the original author.