This comes from the FT this morning:
Received wisdom in the banking sector is that higher rates are great news. US banks, with their heavy domestic focus, can push a Federal Reserve rate rise on to many of their borrowers pretty quickly. They can also try to delay passing the benefit on to savers for as long as possible. Foreign banks with US operations get the same benefit, but on a smaller portion of their business.
To summarise: an increase in Fed or Bank of England interest rates would simply provide a profit opportunity to banks. Borrowers would pay them more. Savers would gain not a penny. The banks would pocket the difference.
And you wonder why banks are so keen on a return to 'normal times' with more 'normal' interest rates?
It is hard to see how at present an increase in rates could be a move in the national interest.
In fairness, the FT is not sure that it will be either, concluding the thoughtful piece by saying:
After such a long period of low rates, any increase will be a welcome relief for many banks. But with potential problems in emerging markets, increased regulatory scrutiny and the threat around customer loyalty created by the growth of internet banking, rising interest rates will not be the one-way bet some banks suggest.
And therein lies the problem: bankers making judgements for their own interests do not necessarily get things right.
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This is of course true. Banks will always benefit from rate increases.
But it is worse than that:
It is also worth looking in detail how “monetary policy” is conducted at the moment. We (the Bank of England) pays private sector banks at the moment for the money we gave them through QE. That money ended up as deposits by the banks with the Bank of England. We (the Bank of England) pays interest on this money deposited by commercial banks. That is the official rate of 0.5%.
That allows the banks to make an additional profit of currently more than £1.5bn a year which they would not have had otherwise, if the Bank of England simply stopped the interest payments.
But at the moment the talk is of increasing interest rates. If the Bank of England would double interest rates from 0.5% to 1%, that would increase the subsidy of banks to £3bn a year.
I think that should be the first question on Prime Minister’s Question on Wednesday, because that is a scandal.
My blog has more details.
https://radicaleconomicthought.wordpress.com/2015/09/13/why-does-the-bank-of-england-waste-1-5bn-a-year/
If you think I am making this up (increase in interest rate = increase in subsidy to bank profits), please read the NYT article here, talking about the impact of interest rate rises. And especially the following section:
“This is not a cheap trick. Since the crisis, the Fed has paid banks a token annual rate of 0.25 percent on reserves. Last year alone, that cost $6.7 billion that the Fed would have otherwise handed over to the Treasury. Paying 1 percent interest would cost four times as much. ”
http://www.nytimes.com/2015/09/13/business/economy/the-feds-policy-mechanics-retool-for-a-rise-in-interest-rates.html?_r=0
Dear Richard,
You over simplify and exclude major points in your blog. Firstly since the Bank of England prints money via quatative easing it no longer has to sell bonds and therefore maintain financial disapline. Private banks have to retain UK government debt on there balance sheet. If the private banks had a choice they would not buy UK gilts since the risk of capital loss far outweighs the income. The banks would invest elsewhere.
I am like you a qualified accountant and tax adviser who studied applied economics at university and in simple terms if on the 1september 2015 the UK balance sheet consists of £1000 billion pound, ie the measure of UK wealth and on 2 September 2015 the Bank of England print a further £1000 billion then the UK wealth has doubled in terms of the measurement . Wealth has shifted to those who are highly geared.
Regards,
Nick
Nicholas
I do not follow the logic of your second para: no one prints money for the sake of it. What is the double entry you are suggesting?
Re the first para: bank regulation does exist for good reason. Why try to ignore it?
Richard
Richard,
It is the government who gains by quantitive easing. Instead of maintaining balanced and sustainable finances the government can spend beyond its means and effectively buy votes.
Since the government run the treasury, who in turn own the Bank of England any double entries would cancel out. I am not sure where your going with the double entry. Yes the Bank of England can print money and buy gilts and therefore the treasury have extra money to spend. But the extra money the treasury now have has been misappropriated from me and you. Since my £s have become that £375 billion faction worth less than they were before QE.
Regards
Nick
Not one penny has been misappropriated from you
QE creates new money
This seems to be an expression of the world view that the banks own that 375bn of QE created money and have it on deposit with the BoE earning them a sweet 0.5% rate of interest.
But those same banks could go round the corner to each other and get deposit rates of around 1.0% or in 2009 until when QE ended they could have bought shares in National Grid or many other companies and gotten 3% or so. So why are the banks leaving £375bn on deposit at the BoE?
“So why are the banks leaving £375bn on deposit at the BoE?”
In total from the whole UK banking sector there are £315bn on deposit at the Bank of England, from their latest statistics. That will earn them about 1.5bn of interest per year.
If there were better opportunities to lend the banks would. They can go to other banks which would offer them more money on their deposits, but the sector as a whole has too much money. So lending out the money seems to be difficult. Perhaps the demand for loans is low. Or the lending criteria too strict, or the interest rates at which the bank lends money out too high for potential borrowers. Or everybody has borrowed as much as they can, and they do not want to borrow any more. That is why the money stays at the Bank of England.
It might be that the banks are still running up against equity constraints (the Basle regulations), so they do not want to lend out more, because they do not have the equity base (shareholders funds) which is needed to comply with regulatory requirements.
But really I do not know.
The Bank of England used to publish a report on how lending was going. A quarterly report in “Trends in Lending”. The last issue was published in April this year. Why they have stopped that, I do not know either.
http://www.bankofengland.co.uk/publications/Pages/other/monetary/trendsinlending.aspx
Thanks for your honesty. I’m assuming the 315bn figure comes from the drawable amount figure on the 2014/15 annual report.
Contrast though to the 2007/08 annual report which says 47.3bn of drawable value was held with the BoE, but interest rates were 5.25% on 29 Feb 2008 which is the date used in that report.
Applying the same formula on payable interest suggests the UK public is getting a better deal now from collateral held with the BoE than it was 7 years ago.
But nobody dares to celebrate this little fact for risk of being accused of bank-loving neo-liberal bigotry. Interest rates are staying exactly where they are for a good while yet, so no-one should lose sleep.
But suppose the banks have to leave all that collateral with the BoE because they are constrained i.e. they are being compelled to do so. For the banks, there is an opportunity cost which is what they could otherwise be doing with those securities which would give a better rate of return, but our scaredy cat masters don’t want more risk taking by the banks, at least not for a long time yet.
With very good reason indeed
There is already too much private debt in the economy
And quite right too: there is far too much long term debt now
That’s my opinion too, but unlike you I don’t want a command economy imposing that opinion. Lending to young businesses is low as banks won’t take risks with them. Meanwhile at the older end of the debt spectrum the amount of debt being liquidated is low.
I would want a National Investment Bank to have a venture capital arm for a split of capital / mezzanine and plain vanilla lending for new and growing business
That would increase overall levels of indebtedness by individuals and businesses without any debt liquidation to compensate. Why would you want to have national level programme that delivers that outcome?
Such a programme would also crowd out local Regional Aid which mainly consists of grant funding, and the admittedly small amount of capitalist lending already being made to young businesses.
I have no idea what you are talking about
Moral hazard: if rising interest rates collapse the housing bubble, banks are left holding massive stocks of housing with a rental yield of five or six percent. Or fifteen percent, in London, if prices fall by half.
They will, of course, be technically insolvent – all those defaulted mortgages – but the bankers know damn’ well that they’ll be bailed out, and all of them will keep their bonuses and pensions.
The rental stock will have to be taken off the balance sheet, eventually… With the reinvigorated and recapitalised banks lending money to the buyers before rents return to sensible levels.
The real worry for investment bankers is a liquidity crunch; and it is salutary to note that QE isn’t doing very much for liquidity today, let alone after an economic shock
According to Roberto Saviano (author of Zero) it was banks money laundering cocaine money that provided the only liquidity in the 2008 crash!
Land value tax is needed, not high rates.
“deposits by the banks with the Bank of England”
so why – pray – is the BoE not lending the deposits it holds to projects that offer a return in excees of the 0.5%? (apologies – of course this is a rehtorical question – it does not because it ain’t allowed to – or is this really the case?).
It could
I have shown it has the authority to do so – from the Treasury
Ben Bernanke’s 2002 speech on deflation is interesting.
http://www.bis.org/review/r021126d.pdf
His arguments would appear to suggest that given any sovereign government’s inability to have all the right tools to rapidly respond to both deflation and inflation the one thing it can do is use its powers to create money from nothing to ensure a positive interest rate on savings to ensure a climate for continuing investment in the production of “real” goods and services for its country’s economy. The question then becomes who shall be the beneficiaries, for what amounts, for what periods and whether manipulation of reserves interest rates should be eschewed as an inflation/deflation regulator in favour of a rapidly effective progressive taxation mechanism.
This might suggest a form or forms of National Savings with no time limit but with a value limit for individual citizens, a time limit but no value for private companies that want to accumulate for investment or takeover purposes rather than rely on bank borrowing, stock or bond issues and finally no option for commercial banks to place money in National Savings schemes.
Matt: is the BoE lying when it says here that QE did not involve giving any to the banks? The gilts were purchased from pension funds and insurance companies, apparently.
http://www.bankofengland.co.uk/monetarypolicy/Pages/qe/qe_faqs.aspx
Gilt holdings by banks have increased
Bank gains from QE were due to reinvestment of proceeds, not direct gain
Where did the proceeds come from if they didn’t hold the gilts in the first place? The holdings of gilts by banks before QE were practically zero; so there was nothing to sell. Their holding of gilts has increased. That strongly suggests they have net bought gilts not net sold them.
There are technical reasons why the holdings increased
But the increased liquidity created by QE when banks refused to create it resulted in significant net gain to banks
Under what mechanism did they gain? To gain they have to sell something for a profit (but they didn’t hold the gilts at the start of QE) or earn a return on an asset over and above what they would have earned (but rates went down) or funded themselves more cheaply(but gilts are an asset not a liability for the banks). Where’s the gain?
Also, the BoE site says the mechanism lowers interest rates for households and businesses. The other day you were saying that banks gain when rates go up but here they are going down.
You ignore their role as traders in financial assets
But this is from the Bank of England report on the distributional effects of the £375bn of QE. “Purchases of financial assets — which in the United Kingdom have largely been UK government debt (gilts) — from the non-bank private sector financed by the issuance of central bank money”.
The banks weren’t required as middle men in the transaction.
I have to say you are tediously repetitious
The banks made money from the trading that the injection of QE gave rise to
No one seriously disputes that
Please do not waste my time doing so
Richard…Before QE the banks held almost no gilts at all. During QE bank holdings of gilts rose. Now, with QE maintained but not expanding, banks hold lots of gilts. So, how have banks got money by selling gilts into QE? I don’t understand.
Others sold gilts
Banks made a great deal from trading with resulting liquidity that was created
So banks make money from banking. Why wouldn’t that happen under PQE. The banks would do banking with that money too.
Because the money would have found a home in the first instance in goods and services
The location of stage one of the multiplier would have been pre-determined to best effect
And yes, babnks would make money, but I would also propose higher tax rates for banks
“Matt: is the BoE lying when it says here that QE did not involve giving any to the banks? The gilts were purchased from pension funds and insurance companies, apparently.”
Good question, I would like to know who were the owners of the bonds before the Bank of England bought them? There should be some statistics published on this, surely, but I cannot find anything.
I would think the big bond trading departments of the banks would have bought quite a few bonds just before or after Lehman Brothers crash. Sensible thing to do, rates will come down (after a crash official rates will always go down), value will go up, and you can then sell them at a profit. Plus, in a financial crisis, government bonds probably the safest asset class you can hold.
Except, as everybody is doing it, the big bond trading departments of the banks cannot then find buyers after the rates have bottomed out. There is an illiquid market. Nobody was buying anything after 2008. Every financial market is crashing.
Banks balance sheets start shrinking, because people repay their loans, so the banks have to sell assets, to be able to repay deposits which are withdrawn. Normally they could sell government bonds, which are highly liquid, but not in 2009. So BoE steps in to rescue them.
That is the theoretical explanation. Whether this is what actually happened, we do not know, as we do not know who sold the bonds to the BoE.
“Savers would gain not a penny.”
To be fair that is HM Treasury’s fault. They can always up the rates at National Savings and the banks then have to follow suit
Good point
It is a slightly different point, but there is a lot of anti-money laundering regulation around and while we clearly need to ensure these checks take place they are a real hurdle to people moving accounts from one bank to another. Wouldn’t it be good to have a standard set of the required KYC documents that banks would be obliged to share with each other if requested to do so by a client? So if I am with Bank A and want to leave them and move to Bank B I would simply contact Bank B, tell them I want to set up an account and ask them to get my KYC from Bank A, and Bank A would be obliged to comply.
If the KYC is inadequate, Bank B could have a duty to report any inadequacy to the regulator. If it is adequate, Bank B would be obliged to accept it: a binary choice. In this way, clients would be able to move freely, there would be more competition as a result, and adhering to KYC requirements could be partially policed by the banks themselves. As it is, competition between banks is largely a myth for those with smaller balances.
For once, a good idea Roger
I think that is now necessary
There no good reason for interest rates to rise on either side of the Atlantic other than to try to convince everyone that the US and UK economies are starting to improve as politicians like to claim.
It must cause some discomfort that interest rates are so low. The conventional wisdom, according to the New Keyensians (who are really Keynesians at all BTW) is that interest rates vary about some long term value of a few percent. They are lower than average in the bad times, to stimulate the economy, and higher than average in the good times, to prevent inflation.
It’s all bollocks -not to put too fine a point on it. The economy can’t be controlled this way. Private debt gradually increases, clogs up and slows down the system, and interest rates end up at or near zero with everyone wondering what to do about them and muttering about the “special case of the zero bound” etc.
So interest rates have to be kept at close to zero for the foreseeable future. If and when fiscal stimuli become effective and inflation starts to take hold, we can then think about increasing interest rates to prevent too much debt accumulating in the economy.
Hopefully this episode (38 years of it) will at last be discredited and monetarism as a supposed controller of the money supply dead and buried with the idea that interest rates do the job. Hopefully, Corbyn/McDonnel can make the case for fiscal measures that create net assets in the real economy and for real social purpose.