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Peter Crabb: Why lend to local businesses when loans to the government are so profitable?

This appears to be the question bankers across the United States are asking themselves.

According to data released by the U.S. Federal Reserve this past week, commercial and industrial loans made by U.S. banks are declining rapidly, from nearly $1.6 trillion last year to only $1.4 trillion today. Meanwhile, banks now own as a group, $1.4 trillion of U.S. government debt such as Treasury and Fannie Mae bonds. This is 19 percent higher than the same time last year.

Bankers are asking themselves why take risk when they can make a nice profit from the government. Current monetary policy gives bankers little incentive to lend to small or even medium size businesses.

Banks can borrow at short-term rates near zero through the interbank market or at less than 1 percent from depositors. These funds can be quickly turned around and invested, with little work such as credit checks and servicing, in higher yield Treasury notes and bonds.

Idaho banks are not surprisingly making the same profitable investments. In their quarterly report released at the end of October, Sandpoint-based Intermountain Community Bancorp reported good increases in deposits and improvements on their regulated capital ratios.

The bank also reported that cash holdings and Treasury like investments were more than 30 percent higher than the same period last year. But over the course of this past year, loans on their balance sheet declined by 9 percent. Commercial loans were down 4 percent.

Banks throughout the country will continue to hold onto their cash or lend it to the government rather than businesses as long as the cost of getting funds remains low.

Policymakers see little reason to change their current stance, which is fostering this anti-business loan mentality. They don’t see a reason to raise rates. In a speech this week, Federal Reserve Bank of Dallas President Richard Fisher said economic activity and inflation is likely to remain low for some time.

The macroeconomic consequence of such inaction will be a continuing decline in the value of the dollar, as measured both against other currencies, such as the Japanese Yen, and gold. But the problem hits closer to home since banks have little incentive to lend to our local companies and employers.

On positive note, local banks may soon see a turnaround in business opportunities. Industrial activity is picking up in the Treasure Valley.

According to Thornton Oliver Keller’s Monthly Market Review, the vacancy rate for industrial properties fell from 12.4 percent to 11.9 percent in October. While the decline was driven by one large renter, this was the largest drop in this segment of the market since the summer of 2006.

The positive move mirrors industrial activity at the national level. According to the Federal Reserve’s most recent report, industrial production rose 0.7 percent in September and 1.2 percent in August.

Hopefully, bankers will soon see more opportunities in commercial lending, and the government will stop distorting their incentives.

Peter R. Crabb is a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon.

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