Good evening Superstonk, I hope everyone is enjoying a wonderful Friday evening!
Reminder, while banks have the liquidity fairy, 'we' get the promise of 2 more rate hikes this year, Atlanta Fed President Raphael Bostic yet again enrichens himself inappropriately from his position.
What I want to talk about tonight is something new--Commercial and Industrial Loans, All Commercial Banks.
What are Commercial and Industrial Loans?
Commercial and Industrial (C&I) loans are loans made to businesses or corporations, not to individual consumers. These loans can be used for a variety of purposes, including capital expenditures (like buying equipment) and providing working capital for day-to-day operations. They are typically short-term loans with variable interest rates 1.
C&I loans are a key driver of economic growth because they provide businesses with the funds they need to expand, invest, and hire, which can stimulate economic activity. They are a major line of business for many banking firms as they provide credit for a wide array of business purposes 2.
As interest rates have risen, it has becomes more expensive for banks to borrow money. This increased cost can be passed on to businesses in the form of higher interest rates on commercial and industrial loans. This means that businesses would have to pay more to borrow money, which would make them less likely to take out loans for things like expansion or equipment upgrades--lining up with the recent downturn we can observe:
Commercial and Industrial Loans hit a recent high in January of 2023. ($2,815 billion)
|Date||Commercial and Industrial Loans, All Commercial Banks ($ billions)||Down from all time high (billions)|
|February 2023*||$2,807||-$8 billion|
|March 2023||$2,795||-$20 billion|
|April 2023||$2,774||-$41 billion|
|May 2023||$2,767||-$48 billion|
|June 7, 2023||$2,752||-$63 billion|
|June 14, 2023||$2,765||-$50 billion|
|June 21, 2023||$2,762||-$53 billion|
|June 28, 2023||$2,754||-$61 billion|
However, the Fed has created an emergency backstop program so that banks won’t have to sell assets into the market if customers pull deposits in search of more attractive yields for their savings....
|Date||Bank Term Funding Program (BTFP)||Up from 3/15, 1st week of program ($ billion)|
|3/15||$11.943 billion||$0 billion|
|3/22||$53.669 billion||$41.723 billion|
|3/29||$64.403 billion||$52.460 billion|
|3/31||$64.595 billion||$52.652 billion|
|4/5||$79.021 billion||$67.258 billion|
|4/12||$71.837 billion||$59.894 billion|
|4/19||$73.982 billion||$62.039 billion|
|4/26||$81.327 billion||$69.384 billion|
|5/3||$75.778 billion||$63.935 billion|
|5/10||$83.101 billion||$71.158 billion|
|5/17||$87.006 billion||$75.063 billion|
|5/24||$91.907 billion||$79.964 billion|
|5/31||$93.615 billion||$81.672 billion|
|6/7||$100.161 billion||$88.218 billion|
|6/14||$101.969 billion||$90.026 billion|
|6/21||$102.735 billion||$90.792 billion|
|6/28||$103.081 billion||$91.138 billion|
|7/5*||$101.959 billion||$90.016 billion|
*First decrease in usage since BTFP launched.
- Association, or credit union) or U.S. branch or agency of a foreign bank that is eligible for primary credit (see 12 CFR 201.4(a)) is eligible to borrow under the Program.
- Banks can borrow for up to one year, at a fixed rate for the term, pegged to the one-year overnight index swap rate plus 10 basis points.
- Banks have to post collateral (valued at par!).
- Any collateral has to be “owned by the borrower as of March 12, 2023."
- Eligible collateral includes any collateral eligible for purchase by the Federal Reserve Banks in open market operations.
Richard Ostrander (one of the architects of BTFP) spoke about it the other day:
When the Federal Reserve established the BTFP, the lawyers of the New York Fed played an important role in facilitating its rapid implementation. I was responsible for coordinating among my team of attorneys at the New York Fed and the Board of Governors to ensure that our actions complied with applicable statutes and regulations.
Over the weekend of March 11 and 12, the Fed designed the BTFP to support the stability of the broader financial system by providing a source of financing for banks with Treasury, Agency and other eligible holdings whose market value had significantly diminished given interest rate increases.
There was not enough time to set up special purpose vehicles as the Fed had done for some of the pandemic programs. The only way to have the program up and running so quickly was to leverage our discount window facilities.
As a result, we turned to Section 13(3) of the Federal Reserve Act, which authorizes specialized lending in unusual and exigent circumstances. The BTFP extends the maximum term of lending from the Section 10B limit of four months up to a special limit of one year. Additionally, unlike traditional discount window operations, the BTFP authorizes banks to borrow against eligible holdings up to their par value rather than their market value less a haircut
It is starting to smell idiosyncratic all up in here:
To me, this is looking more and more like over-reliance on Central Bank Funding!
As banks seem to be relying on these programs as a regular source of funding, it will lead to several issues:
Moral Hazard: Banks might take on more risk than they would otherwise, knowing they have a safety net in the form of cheap funding from the central bank.
- This could lead to riskier lending and investment practices, potentially setting the stage for future financial instability.
- Distorted Market Signals: In a healthy market, interest rates and other signals help guide banks' lending and investment decisions. But if banks can always access cheap funding from the central bank, they might ignore these signals. This could lead to an inefficient allocation of resources, with too much credit going to certain sectors and not enough to others--current AI bubble anyone?
- Reduced Market Discipline: In normal circumstances, banks should be disciplined by the market: if they take on too much risk, they should face higher funding costs or even risk bankruptcy. But if banks can always rely on central bank funding, this market discipline could be weakened, potentially leading to excessive risk-taking...
- Commercial and Industrial (C&I) loans are loans given to businesses, not individuals. They're used for things like buying equipment or providing working capital for day-to-day operations.
- These loans are crucial for economic growth because they give businesses the funds they need to expand, invest, and hire, which can stimulate economic activity.
- But here's the thing: C&I loans hit a high in January 2023 at $2,815 billion. Since then, they've been on a bit of a slide. By the end of June 2023, they were down to $2,754 billion - that's a drop of $61 billion from the peak.
- The Fed has created an emergency backstop in BTFP so that banks won’t have to sell assets into the market if customers pull deposits in search of more attractive yields for their savings.
The Bank Term Funding Program (BTFP) is essentially putting a finger on the scale of the free market.
- While it's designed to provide liquidity to banks during times of stress, it is distorting market operations.
- Banks can borrow at a fixed rate through the BTFP, effectively shielding them from rising interest rates.
- Meanwhile, businesses and consumers face higher borrowing costs as the Fed raises rates.
- This two-tiered system - liquidity for banks, rate hikes for everyone else - has set us on a disastrous course as it discourages businesses from borrowing and investing, slow down economic growth, and exacerbate wealth inequality.