Bank Lending: Part of the Problem or Part of the Solution?

The conventional wisdom says that low interest rates encourage banks to lend more because more borrowers come knocking on the door. So why, when the Fed funds rate is as close to zero as it is ever likely to be, has bank lending declined?

A new working paper from the National Bureau of Economic Research (NBER) offers some data to try to answer that question. Titled "Banks Exposure to Interest Rate Risk and The Transmission of Monetary Policy," the NBER report indicates that the country's largest banks have reduced their outstanding loans, most likely for the very good reason that lending money at very low interest rates is not profitable.

The big banks largest customers - U.S. companies - have gone to the bond markets for needed financing and have taken advantage of the low interest rates without help from the banks.

Smaller banks have behaved in a more traditional way and have increased their lending. Lending at Citigroup Inc. (NYSE: C) fell from $604 billion in 2011 to $601 billion in 2012. At Bank of America Corp. (NYSE: BAC) lending fell 2% in 2012, to $912 billion, according to a report in Fortune. At Apple Bank of Savings, however, the 100th largest bank in the United States, lending rose 58% in 2012.

One thing cheap money has accomplished is to boost equity prices, and today's highest-ever Dow level is testimony to that. When interest rates begin to rise again, then the big banks will resume lending and equity prices may pull back. But we are likely to have to wait at least another year to see if that happens.

Filed under: 24/7 Wall St. Wire, Banking & Finance, Economy, Research Tagged: BAC, C