What Does Quantitative Easing Mean for Banks?

The Federal Reserve today announced a new quantitative easing plan in which they will buy $600 billion of long-term Treasury securities. What does this mean for banks?

Bank deposits and reserves will increase. Even if your bank does not sell securities directly to the Fed, some of your clients may be selling securities. Across the country, total bank deposits and reserves will increase. This will put many banks in the awkward position of earning less on their reserves than they pay. The Fed is paying banks 25 basis points on reserves; the FDIC is charging over 30 basis points to most banks for deposit insurance. (Your cost varies depending on the condition of your bank.) The key challenge for bankers is figuring out what to do with the inflow of deposits. There aren’t a lot of great options out there right now.

Deposit growth will rise before loan demand increases. Real estate is largely moribund, though there are increasing opportunities to finance apartments. Commercial lending typically lags the business cycle by two years or so. It will gradually improve, though we have another six months or so before it really takes off.   That leaves consumer lending, primarily made through the big banks. Here the banking industry has two challenges. First, many of the most credit-worthy borrowers don’t care to borrow more money right now. Second, many of the people who would like to borrow are not credit worthy. I expect consumer lending to surmount these challenges as banks nervously ease up on credit standards, and consumers nervously put their toes back in the water.

This is the process whereby the quantitative easing will help. Milton Friedman famously said that the time lags in monetary policy are long and variable. A good rule of thumb these days is 12 months before the overall economy feels the benefit of quantitative easing—and even then, we’ll feel better growth but not normal times.

For community banks, look for core deposit growth in the next few months, well in advance of loan growth.  Twelve months from now, however, loan volume should pick up in both commercial and real estate lending.

Quantitative easing will be positive for the economy, but challenging for the banking industry during the time lag. My top advice to bankers is to carefully plan how they want to deal with higher deposits. In particular, do careful planning on where you want to expand loan volumes.

Comments

[JTapp]

Dr. Conerly,
"This will put many banks in the awkward position of earning less on their reserves than they pay." -- I've not heard this line of thought about the FDIC charges anywhere else. Many have argued that the interest rate the Fed is paying on reserves is keeping banks sitting on those excess reserves. I think the way your post reads, the FDIC charges make the IOR policy a moot point. Am I wrong?

[Lance Van Wyk]

Thank you for an informative article. My question would be whether the "man in the street" saw the benefits of QE1? Did we understand the true impacts it will have and are we not seeing an economic meltdown happening before our eyes with QE2? By reducing the exchange rate of the dollar, there is a real risk of trade retaliation tactics by other countries which could have other consequences for banks and the population at large.

[Quantitative easing]

QE2 does not have the same objective as QE1. QE1 was to prevent a banking collapse, which it did. The purpose of QE2 is to prevent the start of a deflationary spiral, raise asset prices, lower the value of the dollar,etc.