Saturday, December 20, 2008

Is pressuring banks to lend a good idea?

So the Finance Minister has given Canadian banks a deadline to increase lending and Bank of Canada Governor Marc Carney is scolding them for "hoarding" capital. This strategy of leaning on banks is intended to open credit channels and reduce borrowing costs for Canadian businesses. This could be effective if , as the actions of the BoC and the Finance Minister seem to imply, Canada's credit market problems are due to a lack of liquidity rather than heightened risk aversion.

I don't know whether banks are indeed hoarding capital or merely behaving how prudent banks are supposed to behave, ie. rationing credit at a time when default risk is high. Following the work of Bernanke and Gertler and Bernanke and Blinder, perhaps the widening credit spreads we are currently observing in debt markets are due to increased agency costs - that is, costs due to adverse selection, moral hazard and monitoring - arising from an adverse credit shock. Therefore, it could be that banks are behaving exactly the way they should and pressure to lend, especially from government authorities, is not warranted and may even be irresponsible in the long-run.


4 comments:

Wonder Bread said...

I am of the view the banks themselves have ever incentive to lend to business concerns that will likely yield a positive return. Assuming for a moment that lending is declining, this would not be behavior inconsistent with being in a recession (that is, the effect of the recession not the cause).

On the other hand, I rarely see convincing evidence that lending is, in fact, on the decline! A quick glance at the level of bank credit from the St. Louis Fed Database (FRED) shows a clear **increase** recently (see http://research.stlouisfed.org/fred2/fredgraph?chart_type=line&s[1][id]=TOTBKCR&s[1][range]=5yrs). The same trend appears in the consumer credit series, and the total loans and leases series. Perhaps one could make the case that credit is higher than in the past it is lower than what it *ought to be*, but I cannot think of what evidence might be used to establish that claim.

Am I misinterpreting the data? Or are our political leaders merely jumping on the "banks aren't lending" bandwagon without any quantitative evidence to back up their claim? Thoughts?

Shock Minus Control said...

If you look at this: http://research.stlouisfed.org/fred2/series/TRARR

Total reserves in the US have exploded - suggesting that banks are not lending, but rather sitting on reserves. I think the recent behaviour of the effective funds rate supports the idea of an oversupply of reserves.

I'm not sure what the situation is in Canada, or where to go to find comparable data. Perhaps that is a worthy excercise for the holidays.

Wonder Bread said...

I have seen this graph before - and I find it hilarious to see such an enormous spike in bank reserves. However, it merely establishes that they aren't lending an amount sufficient to maintain prior reserve ratios, which is not equivalent to the claim that they aren't lending. The latter claim is clearly false in my view when past lending levels are taken as the proper counter factual (my previous post). The high level of reserves could just be evidence that government planners have forced massive levels of liquidity upon the banks when they don't really need it.

As for Canadian Data, the Bank of Canada releases weekly financial statistics. In their December 19th issue, Table C1 shows bank lending at levels higher than ever. Personal loans at 47.6B (never higher), business loans at 188B (which is lower than november's 190B, but aside from that is the highest ever), and personal lines of credit (167B) are also at record highs.

That being said, mortgage loans are about 30B below their peak levels, but we can agree that mortgage loans were too large before and they may be returning to normal levels. Mortgages crowd out non-residential loans, and these classes of loans are on the rise.

Shock Minus Control said...

Thanks for the tip on Canadian data, i'll check it out.

Interesting perspective on US lending and worth looking into more. I'll have to get into the weeds a bit on the data.