From/via naked capitalism, May 15:
Yves here. This post will likely be an eye-opener to many by describing the very large, ongoing subsidies from central banks to banks via payments on bank reserves. And here you were worried about underpriced deposit insurance!
It tries to unpack why central bankers ever could have rationalized such large gimmies, and here one that has grown as central banks increase interest rates to fight inflation. The authors focus on how central bankers (overwhelmingly monetary economists who follow The Gospel According to Milton Friedman) have accepted the bank lobbyist argument that more efficiency is ever and always a good thing, when in fact any efforts to reduce risk come at a cost.
While this argument is sound, let me point out an additional layer: bank regulators have internalized the idea that they should care about bank profits. Up to a point, that’s not crazy; if banks are going to increase their capital levels, it comes from profits or selling new shares or selling some exiting units at a good price. However, in Japan in its heyday, banks were low earners by international standards. The reason was that bank profits were seen as coming at the expense of the productive economy, and therefore were not to get out of hand. The reason the banks all blew up was not much due to this philosophy, but the rapid deregulation forced on them by the US, primarily for the purpose of making the world safer for US investment banks. It was like taking a drayage company, giving them a 747 and telling them they could fly it because they were in the transportation business. A crash was baked in.By Paul De Grauwe, John Paulson Chair in European Political Economy London School Of Economics And Political Science and Yuemei Ji,Associate Professor University College London. Originally published at VoxEU
Since central banks started their fight against inflation, they have transferred massive amounts of their profits to banks. The authors of this column have suggested that minimum reserve requirements are a valid alternative, but they have met fierce resistance because they are seen as introducing distortions and departures from efficiency. However, the authors argue that successive financial crises have shown there is a trade-off between efficiency and stability. The emphasis of central bankers on using policy tools that do not interfere with market forces comes at the price of less stability and more financial crises.
One legacy of quantitative easing (QE) is that banks have accumulated huge amounts of bank reserves. As a result, the bank reserves market is characterised by a large excess supply. This has kept the money market (interbank) rate stuck at the zero lower bound for many years, until the central banks felt compelled, from early 2022 on, to raise interest rates to fight inflation. Given the excess supply of bank reserves central banks could only perform this feat by raising the rate of remuneration of bank reserves. As a result, this rate of remuneration became the new (not zero) lower bound in the money market (De Grauwe and Ji 2023a, 2023b).
This policy now has created a lot of ‘collateral damage’. Since the stock of bank reserves is extremely high, the central banks now pay out large amounts of interest rate remunerations to banks, which increase with every interest rate hike. We show this in Table 1. This presents the outstanding bank reserves in the euro area, the US, and the UK in May 2023. We also show the interest rates prevailing at that time (second column). The third column presents the total interest payments made by the respective central banks to their domestic banks. The last column expresses these as a percent of GDP....
....MUCH MORE
The story thus far: First we'll give banks the benefit of near-zero percent borrowing costs for thirteen - fourteen years so they can loan that money and make the spread.*
Then, once they've made a few trillion, we'll give them a place to park it risk free while paying them—to reiterate, a risk-free—4-5%.
I can't wait to see what's in chapter three.
*That part was easy to see coming, five days after the fall of Lehman Brothers on Sept. 15, 2008:
It appears there will be a decade long wealth transfer from savers to bankers. To reliquify the big banks balance sheets, the powers that be will let the banks borrow cheap from the Fed or at artificially low shorter term rates, then turn around and lend at higher rates to the Treasury. There is probably a carbon trading angle here too*. You just watch.
It wasn't hard to add up how much the taxpayer would be stuck with, even I could do it:
September 7
...The big losers are the American taxpayers who may be on the hook for a Trillion dollars and who may see their government lose its AAA credit rating, with the increased borrowing costs that implies....
Well it took a couple years but American sovereign debt did get a lower rating for a bit.
