A Meaningful Life

Ironically, now that Federal Reserves are busy guaranteeing bank deposits they have created a whole new set of problems in the competition for capital.

It would be easy to jump to the conclusion that banks should borrow money at the same rate the government does if it’s now the same risk. It’s not that simple. Fussy money (money sensitive enough to deposit rates that it gets moved) is leaving the banks who are reducing their deposit rates to find a new home paying a higher rate of return. That money sometimes just changes bank or asset class within a country but it can also change countries which opens up a whole bunch of foreign exchange activity. So banks need to pay a higher deposit rate than the Government does to attract investment, despite having a Government Guarantee.

If banks lower their deposit rates because they have a government guarantee they risk losing funding. At the same time the margin they make between lending and borrowing increases. This quandary of protecting liquidity versus improved margins is a whole new ‘how low can you go’ game in the banking sector for deposit rates.

We know in business that small increases in prices cause much larger increases in profit. The impact on your P&L is magnified due to the change in your margins (the difference between where you buy and sell your goods). The same magnifier applies to bank margins but also in a far more leveraged way because they usually have around $10 of assets for every $100 of loans and deposits. Even a small 0.10% change in deposit rates (cost of funds) has large implications for profit or lower mortgage rates (in lieu of profit).

Thus an ethical dilemma exists for banks to keep the margin or pass it on. Should banks be forced to pass on any gain from the government guarantee to their borrowers or are market forces best placed to do this?

Many uncertainty that surrounds how long with the guarantee will exist and how many deposits it covers manifests itself in higher deposit rates despite the guarantee.

Personally I’m against the government guarantee, why give banks more help than they need. Why risk seeing capital shift offshore looking for higher rates of return. Why not step in at the ninth hour and save the odd bank that looks like collapsing but only if all other avenues have been explored. This would be better than handing out free money to a sector who have made more than enough over the last 10 years to muscle them through a recession.

Money will always flow toward the best rate for a common risk and liquidity profile in markets. So a government guarantee does not imply you should only earn the same rate from a bank that the government would pay to borrow money. If anyone from a bank tells you otherwise then it’s misleading.