Friday, August 21, 2009

Banks and the Beauty of Cheap Deposits

The WSJ reports:

Domestic U.S. deposits grew nearly $500 billion to a record $7.5 trillion during the year ended in March, according to the Federal Deposit Insurance Corp. And they appear to have kept growing since.
While this is obviously a massive amount of money and a $500 billion increase is nothing to sleep on, the rest of the article makes it feel like this was an outlier event. But as the chart below shows, while overall growth over the past 10 years has been astounding, last year's growth was no outlier.

What this is missing is all the off-balance sheet "cash-equivalent" destruction that took place during 2007-2008. How many individuals were invested in what they thought were highly liquid instruments (ABS ABCP, ARS, etc...) that blew up in the crisis? My guess is that overall "cash-equivalent" securities (which includes these securities, as well as deposits) showed much stronger growth in the 2003-2007 time frame and potentially outright destruction since.

But this part of the article truly confused me...
Crowds of investors sold assets for cash last year as markets tumbled. More recently, a renewed focus on savings has helped swell deposits further.

But overflowing deposits don't necessarily lead to big profits, since big banks have to cover hefty fixed costs for buildings, computers and layers of full-time staff.

In fact, grabbing "wallet share" -- or bankers' speak for winning more of a customer's business -- is so important to profits that banks actually track their progress through various gauges.
Read that second paragraph again:
But overflowing deposits don't necessarily lead to big profits, since big banks have to cover hefty fixed costs for buildings, computers and layers of full-time staff.
Felix Salmon comments:
This makes very little sense. Deposits, to a first order of approximation, are free money. The more free money they have to lend out, the more profits they make. And $7.5 trillion, lent out at an average of say 7%, throws off more than $500 billion per year. It’s hard to spend that kind of money on buildings and computers.
My thoughts exactly. "Buildings", "staff", and "computers"? The expensive bank staff is not fixed, its for the most part variable (the "fixed" staff that performs basic functions doesn't get paid a heck of a lot) and MOST non-financial businesses have these exact same costs. If anything banks have LESS fixed costs relative to any industrial or utility company. Yet these corporations do not have the ability to finance their operations for free (by free I mean 'have you looked at the rate you get on your checking account recently?').

So, I obviously have issues with the article (and I am having a bad day and needed to vent), but the important aspect is $7.5 trillion is a TON of money "sitting" on the sidelines. But like the liquidity sloshing through the financial system, it only matters if / when that cash is put to use. And based on the run up we've seen in deposits over the past decade and desire to maintain a certain amount of wealth in liquid form after the last downturn, I am not so sure we'll see that happen anytime soon.

In which case the ability for banks to finance operations at extremely attractive levels is likely to persist for some time to come.

Source: FDIC


  1. Just reporting a typo... you said 7.5 billion rather than trillian towards the end of the article.

  2. Yeah, cheap money for banks is analogous to a low cost mine. Buffet made this point when he bght Fargo at firesale prices.
    However, eventually credit will have to significantly contract. Its hard to see consumers being in more debt rather than less.
    However this could take along time to occur and in the meantime the banks will continue to make a mint.
    If you look at the Japanese banks they actually did quite well from 1990-1996. It wasn't till the second crisis hit (several years later) that they went down the preverbial drainpipe.

  3. @Anonymous: Billion Trillion... same thing :)

  4. The key component is that they have to lend it out. Aren't they hoarding it, in which case how are they making money (with deposits)?

  5. rather than fund operations by issuing debt at 7%, they can "hoard" deposits at 0%. all else equal, they are profitable. heck, if they invest in 2 year treasuries on their trading side they can earn something (not that i know that they are doing that).

    more likely they're using the deposit base to finance their previous off balance sheet securities. thus, rather than being forced to sell these securities for a loss, they can continue to hold.