The Banking System Through the First Half of 2012

Total reserves in the banking system have actually dropped from June 2011 to June 2012 by about 6.6 percent or about $110 billion.  These are according to the latest figures released by the Federal Reserve.

Yet, required reserves in the banking system have increased by a little over $21 billion during this time period representing a rise of almost 28 percent.

The reason why these numbers are moving in opposite direction is that individuals and businesses are continuing to move their assets from short-term interest bearing instruments into currency or into transaction accounts at financial institutions.

Coin and currency in the hands of the public rose by 8.5 percent, from June 2011 to June 2012.  Cash holdings are continuing to run at relatively high annual rates because a lot of people are keeping their funds in currency these days because of the bad economic times.  This high of a rate of increase in currency holdings is a sign of weakness in the economy and the bad financial condition so many people find themselves in.  It is not a sign of economic health.

The M1 money stock measure increased by 16.0 percent over the past 12 month period.  One can note right off that this figure is down from the March 2011 to March 2012 period which was 17.4 percent and also down from the December 2010 to December 2011 period which was 18.4 percent. 

Since the rate of increase in currency outstanding has not changed much from the end of the year, this means that the other components of the M1 measure of the money stock have declined.  And, this is true.  The June-over-June rate of growth for the non-currency component of the M1 measure of the money stock now rests at 16.0 percent. 

The M2 measure of the money stock was growing by a little more than 9.0 percent in June, down since the end of last year, but this decline has not been caused by a drop in the non-M1 component of M2 which has remained relatively constant through the first half of 2012. 

The movements of funds are very clear:  small-denomination time accounts at financial institutions are down by 17.0 percent, June-over-June; retail money funds are down by almost 3.0 percent; and institutional money market funds are down by almost 8.0 percent. 

Individuals are moving funds from short-term interest bearing assets to currency holdings and transaction accounts either because of their economic situation or because of the low interest rates.

As a consequence, the required reserves at commercial banks have grown quite rapidly.  Since, there are so many excess reserves in the banking system, the total reserves in the banking system can decline while the required reserves in the banking system can increase.  This is not the case in more "normal" times. 

And, the transaction accounts at financial institutions can also increase at historically high rates, at almost 28.0 percent, year-over-year, and yet this rise is not looked on as inflationary because of the massive movement of funds around the financial system.

It can be seen, however, that loans and leases within the banking system are now increasing at a faster pace.  Total loans and leases increased at a 5.3 percent year-over-year rate in June, the highest rate of increase in a long time. 

More specifically, commercial and industrial loans (business loans) expanded at a 14.0 percent annual rate in June, with C&I loans at the largest 25 domestically chartered banks in the United States rising by almost 17.0 percent.  This is the strongest showing since the economic recovery began.

The questions one must ask here are about the type of business loan the banks are making and what kind of impact are these loans having on the various measures of the money stock? 

At the present there is no indication that these business loans are going for productive uses, for purchasing physical capital goods…investment goods.  They may be going into the financing of inventories…physical goods that are not getting sold…or information technology.

Furthermore, if these loans are having any impact on the money stock measures it is small relative to the huge flows of funds coming into the transaction-type accounts from short-term interest bearing assets.  Hence, they cannot be seen as “inflationary” at the present time.     

Commercial real estate loans continue to decline, both at the largest banks and in the rest of the banking system.  As I have discussed many times, this decline will continue well into next year because of the condition of the commercial real estate market.

Interestingly, consumer-type loans at the largest banks, consumer credit and home equity loans, declined over the past year while these types of loans did increase modestly at the smaller banks.

I still have a great deal of concern for the health of the “smaller” banks in the banking system.   Five more depository institutions were closed this past week bringing the total number of banks closed this year to 38. 

But, this is not the only number we should be looking at.  From March 31, 2011 to March 31, 2012 82 banks were closed in the United States.  But, over the same time period, the number of banks in the banking system dropped by 190.  Obviously, quite a number of banks left the banking system during this time period through merger or acquisition.  It is my view that the banking system will continue to lose individual institutions from its numbers, maybe not at the almost 4 per week rate of the period ending March 31, 2012, but at a similarly rapid rate for the next twelve months are so.  This is what the Federal Reserve and the FDIC are attempting to achieve as smoothly as possible. 

The pressure may be lessening in this area.  Over the past three months, the cash assets at both the largest 25 domestically chartered banks in the United States have declined, as have the cash assets at the rest of the domestically chartered banks.  And, excess reserves in the banking system have also declined modestly.

My interpretation of the stance of the Federal Reserve right now is to accept the high rates of growth of the M1 and M2 measures of the money stock as these rates are due to individuals and businesses re-arranging their assets and not due to the Fed’s monetary stimulus.

Business lending may be getting stronger, but, as of this point in time, there is little or no indication that this lending is going into constructive physical assets.  This area, however, needs to be watched.  On the other side, one also needs to continue to watch what happens to the commercial real estate area.  As discussed before, many of these loans are loans that are paid off at maturity and these maturity dates are coming due over the next 12-to-36 months.  Many of these loans may not get refinanced.  This could be very difficult on the banks…especially the “smaller” ones.

Finally, the Federal Reserve…and the FDIC…are still keeping a close eye on the health of the banking system.  Especially the Fed does not want to do anything silly at this time…like it did in 1937…and prematurely remove excess reserves from the banking system before the system is ready to “let them go.”  I still believe that there are a lot of banks in the system that are technically insolvent and that the Fed and the FDIC are being extra careful to “not rock the boat” while these institutions need to be closed or merged out of business.  This remains a major concern at the Fed.