The American Banking System At The End Of July: What's Going On?

by: John M. Mason


The assets of the banking system continues to grow, but most of the growth is still in cash assets.

Foreign-related banks seem to be taking on a major portion of these cash assets and we wonder where the funds are going.

Commercial real estate loans continue to increase the "smaller" banks and what happens here will be very important to the health of the banking system going forward.

Over the past 52 weeks, total assets in the banking system, as reported in the Federal Reserve's H.8 release, increased by $1.2 trillion or 8.9 percent, year-over-year.

Of this increase, cash assets in the banking system rose by more than $625 billion. That is, more than 50 percent of the increase in bank assets was associated with an increase in cash holdings.

Note that reserve balances held at Federal Reserve Banks, a proxy for excess reserves, rose by $665 billion over the same time period.

Over the full 52-week period, cash assets held by foreign-related institutions increased by almost $475 billion, or roughly 40 percent of the total increase. In the past 13-week period, cash assets as these banks accounted for almost 60 percent of the increase while in the past five-week period over 75 percent of the increase come at these foreign-related institutions.

Over the past 13 weeks, cash assets at the 25 largest domestically chartered commercial banks actually declined by $8 billion, with all of the decrease coming in the last five weeks where the decline amounted to $85 billion.

Given these figures, it appears that over the last quarter, a time period that the Fed's quantitative easing had reduced the amount of securities that were being purchased each month to smaller and smaller amounts, that the majority of the new reserves being created were actually going to foreign-related institutions.

Over the past year these foreign-related institutions did increase the amount of commercial and industrial (business) loans that they made by $43 billion, or by almost 17 percent. They also increased their activity in the money markets by $60 billion. The real increase in their balance sheet came on the liability side where Net Deposits Due to Related Foreign Offices rose by almost $190 billion. As has been the case over the past four years, this is one way foreign financial institutions tap into American money markets and then direct the money offshore.

Over the past 13 weeks, these foreign-related institutions saw their cash balances increase by a little more than $180 billion. Net deposits due to related foreign offices rose by $133 billion.

In other words, a lot of the liquidity that is being pumped into US financial market is going to work in other countries. While loans are increasing here, one wonders whether or not the Fed needed to pump as much into the banking system as it did, given that so much has seemingly gone offshore.

A second point that stands out in the data is that commercial real estate loans continue to grow in the rest of the domestically chartered banking system... those banks smaller than the largest 25 in the country.

Over the past year, commercial real estate loans have risen at the "smaller" domestically chartered banks by almost $100 billion.

Note that the largest twenty-five banks only saw commercial real estate loans increase by $13 billion.

Commercial real estate runs primarily through the larger regional and larger community commercial banks in the country. Almost two-thirds of the commercial real estate loans held by domestically chartered banks in this country reside on the balance sheets of the "smaller" commercial banks.

The crucial point with respect to these commercial real estate loans, I have been discussing over the past three years or so is that the majority of them were either approved and not started or were already started when the Great Recession hit. One of the big worries about the loans that had already been started is that they were "payable at maturity" loans and there was great concern about what would happen when these loans came due.

Well, I believe that we are seeing the other side of this problem. As the banking system became flush with liquidity and the pressure was taken off many of the banks, these loans were rolled over and interest due along with enough money to compete the projects were added to the loan amount in order to help the construction companies complete the projects.

Thus, the increases coming from these "rolled over" loans along with the construction projects already approved resulted in a really strong increase in the dollar value of commercial real estate loans on the books of the banks.

The concern now is whether or not these projects will be completed before another shock hits the banking system. The economy needs to achieve sufficient growth so that these projects can be finished and absorbed into the ongoing commerce of the country. Let me just add that I don't think we have completely closed the door on this issue and we need to keep our eyes open for further trouble.

A third issue relates to residential real estate loans…mortgages. Over the past year residential real estate loans at the largest 25 domestically chartered banks have declined by almost $44 billion. Between the legal settlements the large banks have made over issues of mortgage lending and the oversight of the regulators, it is hard to see why commercial banks, except for Wells Fargo (NYSE:WFC), would want to grant residential mortgages.

Residential mortgage balances have increased at the largest 25 domestically chartered banks over the past 13 weeks, but the rise has been miniscule.

Finally, let's talk about commercial and industrial loans…business loans. Over the past quarter, business loans have increased at the largest banks, but at a slower pace than that which occurred over the previous nine months. Business lending is increasing, as it has over the last year, but there is still a lot of evidence that a lot of the borrowing is going to pay dividends, buy back stock, acquire other companies, and help private equity funds, hedge funds, and other private groups acquire other assets to benefit from rising asset prices. Little or no evidence that the business lending is going into areas that would result in the physical investment that would help spur on economic growth and get workers back into the workforce and employed.

The state of the banking system continues to be relatively calm these days. Legal issues still make the the Bank of America (NYSE:BAC) settlement last week. The size of the banking system continues to shrink as more and more banks get acquired. Outright failures do not happen in this environment, only approved acquisitions, and these seem to be resulting in a decline in the banking system of about 200 banks per year. It is my guess that this shrinkage will continue for several more years…being approved and encouraged by the bank regulators.

It does not seem, after five years, that the activity of the banking system is consistent with any strong, steady expansion of the economy. Banks, it appears to me, are still more interested in themselves and where they stand with the regulators than in stepping out and helping businesses grow and prosper.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.