In recent times, the banks have needed the consumer less due to Fed intervention. Read how we're losing purchasing power as inflation continues to grow.
The Federal Reserve has printed more than $9T to buy bonds since 2008, and it still has almost that amount of bonds on its books. But the central bankers didn’t want all of the money they spent on bonds to end up as bank deposits and then be lent into the economy. Such a rush of cash would have created devastating inflation well beyond anything we are seeing today. Instead, the Fed started paying banks interest on the extra money they had laying around, or interest on excess reserves (IOER). This gave banks a way to make a profit, albeit a very small one, on deposits without turning them into loans or lending them to other banks. Today, banks have about $3.5T more in deposits than they do in loans outstanding, whereas before the Great Financial Crisis, the difference was less than $200 billion.
By paying IOER and keeping all of that cash out of the economy, the Fed intended to “sterilize” the money that it printed to buy bonds—and it worked. The Fed was able to print with impunity, driving down long-term interest rates without worrying about creating inflation. But the program wasn’t without side effects.
Banks don’t need us as clients anymore, and it shows. Because banks are flush with deposits from Fed printing and earn interest on all of that cash, they have no incentive to attract depositors by paying market interest rates. This didn’t matter much when the federal funds rate was in a range of 0.00% to 0.25% and banks were paying 0.01% on deposits, but now the numbers are getting bigger. The Fed has raised the federal funds rate to a range of 1.50% to 1.75%, and large banks such as Bank of America are still paying 0.01% on deposits. If you’re a super-special, “Diamond honors” client, the bank pays 0.04%.
Bank profit on deposits has jumped from 0.24% to about 1.70% and will go higher. With the latest inflation reading, it’s likely that the Fed will raise rates at the end of July to at least 2.25%. If banks stay the course, then their profits on deposits will increase to 2.24%, for which they have to do absolutely nothing. The banks don’t have to “earn our business” as either depositors or borrowers. All they have to do is sit on their large holdings of deposits, keep the money in their accounts at the Federal Reserve, and watch the interest roll in.
The cost for this, as with most things, falls on consumers. Since banks don’t need our money, they won’t pay us an interest rate anywhere close to the federal funds rate, so we lose more purchasing power vs. inflation as prices climb. Because banks earn fat profits on their deposits even if they don’t make loans, the banks aren’t motivated to pursue lending clients. This is a great way to guarantee that banks remain solvent, which is one of the main functions of the Federal Reserve, but it would be great if the Fed found a way to do it without draining cash and value from consumers in the process.
By Rodney Johnson The Rodney Johnson Report
For more information on the Federal Reserve and how it affects the economy, watch this video by Rodney Johnson
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