Bank Rates Taste Bitter Medicine in Bank Deleveraging
November 25, 2009
| MoneyRates.com Senior Financial Analyst, CFA
The Quarterly Banking Profile from the Federal Deposit Insurance Corporation (FDIC) showed a dramatic de-leveraging of bank risk levels in the third quarter of 2009. This is a necessary step in curing part of what ails the banking system -- but it is a bitter pill for depositors to swallow.
In the third quarter, loan balances took their largest quarterly drop on record. This is partly because of write-offs of bad loans, and partly because of the slow volume of new loans. Meanwhile capital reserves were up sharply. The loan-to-capital ratio is a reflection of the amount of financial leverage in the banking system. Reducing loan balances and raising the capital base means less risk.
For depositors, that's good news in terms of the overall stability of banks. However, this cure does not come without a cost, and that cost is reflected in the low level of bank rates. Since banks are reluctant to lend, they are increasingly placing their capital in conservative investments. Bank balances at the Federal Reserve grew by nearly 37% during the quarter, and investments in Treasury securities increased by 49%. Since these investments are yielding virtually nothing, banks can ill afford to pay much for deposits in the form of CD rates, savings account rates, or money market rates.
Perhaps the most unqualified piece of good news is that the banking industry in aggregate found its way back to profitability in the third quarter. As the industry finds profitable uses for its capital, it will be more encouraged to pay higher bank rates to attract that capital.
