Prof. Krugman, in yesterday’s NYT column states that QE has been bad for banks because it led to an erosion of net interest margins. And bankers are now in the forefront to ask for a rise in rates, because they want to increase their profitability.
In detail, he says the following:
So we’ve had a long discussion of the distributional effects of QE and all that, which are ambiguous but also, I now realize, irrelevant. Is QE good or bad for capital, for rentiers, whatever? No matter — it’s bad for bankers, because it leads to a compression of the net interest margin, the spread between deposit rates and lending rates. And that is why there’s so much agitation for rate hikes on the part of finance. Furthermore, while I don’t think institutions like the BIS are corrupt in any direct sense, they probably pick up by osmosis from all the bankers they meet the general prejudice against easy money, leading to increasingly baroque attempts to justify rate hikes despite low inflation.
Now is that true? I cannot see any compression of net margins from the graph which Krugman shows us, which could be attributed solely to QE. After QE came in after 2008, margins increased, only to fall back later.
Equally, up to 2008, there were interest rate increases, and margins of banks fell notwithstanding. Margins are falling, but probably through competitive pressures, from the mid 90’s onwards. So QE does not seem to have anything to do with it.
So banks might want us to believe that QE is responsible for erosion of margins, but that seems not the case. My view would be that QE has been neutral, as far as interest margins are concerned.
Incidentally, this also means that the common claim that QE is a giveaway to bankers is the opposite of the truth; to the extent that journalists with close ties to bankers spread this story, it’s Orwellian. Remember, the Fed isn’t lending money at low interest to banks — banks, with their $2.5 trillion (!) of excess reserves, are lending vast sums at low interest to the Fed.
Here, I really do not know what Krugman means. Yes, banks lend money at low rates to the Fed (and in the UK to the Bank of England), but that is their choice. They could always lend it out at higher rates elsewhere, if they chose to do so. It is a management decision by the banks.
We have indeed writers claiming that QE is not “Bank’s QE”, as the FT claimed last Friday. I do not think that particular writer has close links to the banking industry. However, as I pointed out in my response, the banks will have benefited from the fact that in the UK the Bank of England bought lots of bonds from the banks which they sold at a premium price, otherwise they would not have sold. We do not know know at what price they sold to the central bank, or at at which price they could have sold the bonds otherwise, if at all.
The situation with respect to the US programme of QE will have been similar.
Equally, Krugman points out, that $2.5 of excess reserves are in the US banking system at the moment, in the UK the figure is £315bn. On both these balances the central banks pay the banks interest 0.5% in the UK, and 0.25% in the US.
That is a huge transfer of money from the central banks to the commercial banks. $6.25billion for the US, and £1.5bn for the UK per year. All in the name of monetary policy. And the voters are blissfully unaware of this. Because the financial journalists do not make this an issue, and just accept the status quo of the current monetary policies.
So, of course banks benefit from the current monetary policy. And they would directly benefit from an interest rate rise. If interest rates doubled, the money paid to these banks from the government (via the central banks) would also double.
If banks did not benefit, they would attempt to get rid of the reserves, by decreasing deposit rates, so that money leaves the banking system. If banks started charging for their customers for money deposited with them (negative interest rates) then reserves would fall, as money was withdrawn for other, more remnuerative purposes. Banks balance sheets would shrink.
Also, bond liquidity is an issue at present, as set out yesterday in the Sunday Times (gated, but you get the beginning of the story). Now, if it is an issue now, I guess it was an issue back in 2008.
It is now more and more certain, in other words, that the QE programmes in the US and the UK were really just bank rescue programmes. If the central banks had not intervened, the bonds held by the big bond trading desks of the banks would have become impossible to sell, other than at massive losses. Which would of course have meant certain insolvency for the banks. That is my guess.
So the answer to the question “Is QE good or bad for banks?” must be that QE was probably a life saver for the banks, providing them with profits and liquidity at a time of stress, which would otherwise have meant their certain death. And the current policy of paying interest on reserves, a by-product of the large reserve holding, is a further way of ensuring their profitability.
The main beneficiaries of QE will have been banks, there can now be no doubt. So really, there should be an independent audit to confirm this (or reject that theory), as demanded by the Financial Times. A similar audit, carried out in the US about the Fed’s QE, would also clarify the position there.