Why the banking system is broken

One major problem is low interest rates, which mean banks earn little money on the deposits they lend out

Lucas Jackson/Reuters/File
A Citibank sign is seen on the side of a branch in New York in this file photo. the answer to the banking crisis can be found in dangerously low interest rates, Tucker argues.

The New York Times explains a point that has been clear to industry insiders for a very long time but is mostly lost on others. The issue concerns: why does banking seem to be broken? The answer has to do with the ridiculously low interest rates. Banks are drowning in cash – tending toward 100% reserve by default.

Today, banks are paying savers almost nothing for their deposits. As it turns out, the banks are not minting money on those piles of cash. Lending levels have not bounced back from only a few years ago and the loans going out are not keeping pace with the deposits rushing in.

What’s more, the profitability of each new loan has shrunk. Because the Federal Reserve effectively sets the floor off which banks price their lending rates, its decision to lower interest rates to near zero means the banks earn less money on the deposits they lend out.

The banks are also earning less on the deposits left over to invest. They typically park that money overnight at the Fed for a pittance, or invest it in ultra-safe securities, like bonds backed by the government. But with interest rates so low, the yields on those investments have been crushed.

The article also quotes bankers who dream of the day when the economy improves and they can crank out the new money through the credit system. That’s the scary part.

What I don’t get is why the Fed thinks that maintaining 0% interest is going to spur economic activity.

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