Deflation in Bank Lending

Bank lending is deflating. Why, and what does it mean?

The chart below shows the annualized percentage change in the level of commercial and industrial loans made by commercial banks in the United States of America. Having had a positive growth rate from 2011, bank lending has gone into reverse this year with deflation taking place on an annualized basis since March.

There are, of course, base effects at play here. Bank lending grew rapidly in March and April 2020 as companies sought emergency funding in the face of economic lockdowns and so that partially explains the deflation this year. Another reason for the dearth of bank lending could be that, after the shock of 2020, the bond markets became wide-open thanks to Fed underwriting, and thus companies found it easy to raise finance through bonds rather than banks.

However, we can’t escape the obvious conclusion that bank lending is, at best, subdued and that part of that is very probably due to the supply side. Banks are flush with reserves, as can be witnessed by the humungous use of the Fed’s Reverse Repo facility (where the banks give back to the Fed the digital cash the Fed created for them!) Banks are not lending the newly created cash out to the economy. Given the fact that lending is basically how banks make money, we must conclude that a conservative mindset is in operation. Banks are looking at the risk-reward profile for lending to companies and perhaps shying away because of the combination of ultra-low interest rates and impaired creditworthiness. Why lend to companies that have heightened risks of going bust for measly returns?

So, this chart is important because it shows that the amount of money the Fed prints is irrelevant if it is not getting used (lent). Printing money cannot change people’s mindset, which is collectively driven by the trend in social mood. In fact, as with all government / central bank policies, it could have the opposite effect of that intended. Japan flooded the country with yen back in the day, and that hasn’t worked out too well. Can you hear that song in your head again? Turning Japanese. You really think so?