Loan Growth Has Slowed as IOER Has Risen.
The dark blue line tracks the amount of US commercial and industrial loans as a % of GDP. After rising from 2011 into 2016, the amount leveled off and has begun to trend downward.
Loans as a % of GDP is a noteworthy indicator because bank loans, within the context of a fractional reserve banking system, are the means by which the economy’s money is multiplied.
Bank lending is of course a function of the amount of profit a loan will generate, given the amount of risk it entails. The higher this ratio, the more banks will lend.
Day to day, however, banks must adhere to minimum reserve requirements relative to their loans. Any amount above the requirement is considered excess. In the absence of reserve growth, loan growth reduces the amount of excess reserves.
Historically, reserves were acquired through deposits, on which banks paid a short-term interest rate while lending against them at a (higher) longer-term rate. The profit from a loan would be a function of the difference between the short (deposit) and long-term (lending) rate.
However, when the Fed conducted its policy of quantitative easing (QE), it financed its asset purchases by crediting reserves to the banks from whom it was buying. As a result, over the course of three cycles of QE, the banking system amassed more than $2.5 trillion in excess reserves.
In addition to now having no need for deposits and offering depositors virtually nothing for them, banks in the post-crisis era earn Interest On Excess Reserves (IOER, paid by the Fed), and this rate has risen with each of the Fed’s seven rate hikes.
All else equal, higher risk-free IOER makes lending increasingly less attractive. This relationship gains strength as the IOER rate moves higher relative to the longer-term rates banks lend at, which is precisely what has been happening with each Fed rate hike.
Slower loan growth means slower multiplication of money, which in turn means less inflationary pressure. Amidst all the factors generating upward pressure on inflation, this one is arguably pushing back.
Unless otherwise noted, data is sourced from Bloomberg.
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