The impact of banks having too much money

One of the knock-on effects of the monetary support policies introduced to counter the economic effects of the pandemic is that banks are now sitting on more money than they can lend. It's a situation we may not have seen coming. 

Too much of a good thing

 Having too much money causes problems for the banks, borrowers, and depositors. Banks, quite simply, make money by taking cash from deposits (and other sources) and lending it out to individuals and businesses in the form of loans. They charge a higher interest rate on the loan than they give to the investor on their deposit. And the difference is their profit.

 The impact of economic uncertainty 

Today, businesses may not want to borrow because they're not feeling confident about the future. The impact of our government's response to the pandemic has led to lockdowns and restrictions that have severely affected their bottom line. As a result, many businesses simply don't know how much longer they'll be able to continue to trade. And if they can continue, they're uncertain about their future profitability and cash flow. 

 Moreover, even if a business does decide to borrow, whether they'll secure the sum they need is another matter. Regulations have tightened since the days of the GFC, and banks have become increasingly conservative. What's more, the loan approval process has been extended, meaning any business must jump through a lot of hoops to qualify for a loan – all of which discourage many from applying. And even if approval is granted, the approval process takes a lot longer than it did in pre-COVID days.

Keeping cash close to hand

Today, people here in Australia and all around the world are holding onto far more cash than they were before the pandemic. There are numerous reasons for this. Uncertainty about the future is one of them. But stimulus payments, the ability to withdraw cash from super, strong financial markets, ongoing monetary policy and good economic recovery all contribute. 

The result is that far fewer people are looking to borrow. And this is terrible news for the banks. If the need for loans drops significantly, the banks end up sitting on more and more money without benefitting from interest payments because demand is so low. 

A lack of incentive to invest in term deposits

This leads to another problem. If banks aren't lending as much, they don't need cash in the form of term deposits, so the rates they offer are historically low. This situation has led to many investors choosing not to invest in term deposits because the interest rates they'll get in exchange are at an all-time low. 

Instead, they're opting for the convenience of at-call and mortgage offset accounts. Unfortunately, this is a worst-case scenario for the banks because both options mean they're benefitting even less from the capital they're holding. Additionally, storing money in mortgage offsets reduces the amount of interest paid back to the bank by the customer. 

So, how are banks making money? 

Australia's banks' profits and dividends are recovering despite low loan take-ups because they have existing loans on their books. Customers still owe them money, so they continue to make a good base profit on these loans. Plus, credit card interest rates remain obscenely high. And the same is true for personal loans. 

Reducing costs and balancing books 

In addition, banks are always looking to reduce costs. They're mainly doing this through the adoption of technology and having customers do a lot of the work for them.

What's more, during the height of pandemic uncertainty, banks were required to offer customers repayment holidays, and they feared many would default. Therefore, they allowed for losses in their last financial statements, which further reduced their profits. 

However, it now appears that there will be far fewer defaults due to the federal government's ongoing support programs. This means the banks can now write back in the previous allowances made for defaults, which adds to their recent profits.

What happens next remains to be seen. But while all this extra cash in the system may not be the best news for banks, it does mean that if you're considering where to put your money, you may want to talk to your financial advisor about investing in asset classes with better returns.

by Gary Lucas.