The cause of the loan-growth rut
2017 is the worst year for business-loan growth since 2010, according to "Loan Growth is in a Rut” (WSJ, 11/27/17). 2017 also happens to be when the Fed rate hikes started taking hold. Why would Fed rate hikes reduce loan issuance?
Short term rates used to be a cost for banks. No longer. Now that the banking system is flooded with cash from the Fed, banks do not pay each other for borrowing overnight. Now, the Fed simply pays all banks a 1.25% annual subsidy for parking excess funds with them overnight. This is risk-free money for banks. The more this overnight rate goes up, the less attractive it becomes to lend to the real world where there is potential for default.
It does not help that the Fed is holding down long-term rates by continuing to purchase long-term Treasuries to replace Treasuries maturing on their balance sheet. That makes lending even less appealing for banks. Today's yield curve is being manufactured by the Fed on both ends like never before.
The lure of risk-free money earning 1.25% will only increase if, as expected, the Fed Fed boosts this overnight subsidy further. Expect loan growth to decline further if the Fed continues down this path.
Everyone asks when and how much the Fed will raise the Federal Funds rate. A better question is when does the Fed plan to let the market determine the yield curve. Reduce the balance sheet to zero. Soak up the excess funds. Then we will witness a real yield curve and a return to real banking.