Monday, November 25, 2013

A Glimpse of the Monetary Hot Potato- A Fee on Your Deposits

As I showed here, Mises described the three step process in which money printing can (at least in the first step) lead to a lower velocity of money, as the demand for money increases, helping maintain the purchasing power of the dollar. Moving into the second and third step would take some event or series events that would cause businesses and individuals to decrease their demand to hold money.

We may have just seen the first signs that these later phases are closer than many believe or understand. In the latest Fed minutes from the October meeting, the Federal Reserve board openly discussed the idea of cutting the interest rates on reserves kept with the Fed that it pays to the banking system. As most investors and the media fawned all over the idea of taper occurring sooner rather than later, this announcement was largely ignored. More so and in response a number of banking concerns discussed charging depositors a fee for deposits kept by the banks. This is discussed here in an article by the

Leading US banks have warned that they could start charging companies and consumers for deposits if the US Federal Reserve cuts the interest it pays on bank reserves.

Depositors already have to cope with near-zero interest rates, but paying just to leave money in the bank would be highly unusual and unwelcome for companies and households.

The warning by bank executives highlights the dangers of one strategy the Fed could use to offset an eventual “tapering” of the $85bn a month in asset purchases that have fuelled global financial markets for the last year.
Critic’s staff make overtures to US banks 
Minutes of the Fed’s October meeting published last week showed it was heading towards a taper in the coming months – perhaps as soon as December – but wants to find a different way to add stimulus at the same time. “Most” officials thought a cut in the interest on bank reserves was an option worth considering.
Executives at two of the top five US banks said a cut in the 0.25 per cent rate of interest on the $2.4tn in reserves they hold at the Fed would lead them to pass on the cost to depositors.

Banks say they may have to charge because taking in deposits is not free: they have to pay premiums of a few basis points to a US government insurance programme.

“Right now you can at least break even from a revenue perspective,” said one executive, adding that a rate cut by the Fed “would turn it into negative revenue – banks would be disincentivised to take deposits and potentially charge for them”.

Other bankers said that a move to negative rates would not only trim margins but could backfire for banks and the system as a whole, as it would incentivise treasury managers to find higher-yielding, riskier assets.
“It’s not as if we are suddenly going to start lending to [small and medium-sized enterprises],” said one. “There really isn’t the level of demand, so the danger is that banks are pushed into riskier assets to find yield.”

The danger of negative rates has deterred the Fed from cutting interest on bank reserves in the past. If it were to do so now, it would most probably expand a new facility that lets banks and money market funds deposit cash at a small, positive interest rate. That should avoid any need for banks to charge depositors.
About half of the reserves come from non-US banks that do not have to pay the deposit insurance fee. Their favourite manoeuvre is to take deposits from money market funds and park them overnight at the Fed, earning millions of dollars risk-free. Cutting the interest on reserves would stop that.

Lowering interest on reserves would also affect money market funds, said Alex Roever, head of US interest rate strategy at JPMorgan.

“[It] would decrease the incentive for those banks to borrow in the money markets, which in turn could leave money market funds short of certain investments and force them to bid up the price of their next best options,” he said.

Richard Gilhooly, strategist at TD Securities, highlighted some benefits to the Fed from the possible cut: “[It] would not only anchor short-term rates near zero, it also stands to boost the profits for the Fed as they pay less interest to banks,” he said.

Have no doubt, a reduction in the interest rates banks receive for holding reserves at the Fed will reduce the amount of reserves banks are holding on their balance sheets. Additionally, a fee on deposits will likely lead to businesses and individuals draining their saving deposits from banks, reducing the demand to hold money and increasing the velocity of money.

Although it remains uncertain if the Fed will cut rates on reserves or banks will start fees on deposits, this is a road sign to watch.

No comments:

Post a Comment