Saturday, September 19, 2009

As LIBOR declines, banks hoard more cash at the Fed

US Banks continue to hoard over $850 billion in cash at the Federal Reserve. They are required to hold some reserves there, but since the Fed started paying interest on deposits last year, that amount spiked and stayed at these elevated levels.

In fact that deposit amount has been rising recently. The reason has to do with the collapse in interbank deposit rates (LIBOR). The chart below shows just how flat the LIBOR curve has become:

Out to 3 months the rate is almost the same as the overnight rate. It's an indication of the spectacular rise in confidence banks have in each other and their own ability to fund themselves short-term. If you are a bank treasurer however, and you have a choice of depositing your excess cash with other banks or with the Fed at almost the same rate, your preference would be to park the money with the Fed. And that is exactly what is taking place with the decline in LIBOR rates.

Part of the problem with Western banks these days is that much of the liquidity is trapped within the banking system. One way some central banks have been dealing with this is to lower the deposit rate on reserves to zero, and even below zero. This forces banks to look for a better place to put the money and possibly do some lending. But it continues to be a challenge to encourage banks to lend outside the banking system; they either lend to each other or to the central bank (via reserve deposits).

So far in the US there is no evidence that much of this cash is making it's way to the consumer. Consumer loans outstanding at commercial banks have actually been declining.

source: the Fed

That is why the expectation is for the Fed to stay put for a while with respect to rates. Until some of the liquidity the banks are hoarding in reserve deposits is unlocked, consumer credit will continue to stay constrained.