Banks Piling Up Cash Reserves, More Reluctant to Lend ... But Why?

Here at Weiss Ratings, our data gives you a wealth of information about the state of the banking industry. One trend jumps right out at you today: Banks are piling up gigantic cash reserves, and are more reluctant to lend than in years past.

Let’s start with the reserve data. The ten largest deposit holding banks have increased their cash reserves from half a trillion dollars to $1.66 trillion in just six years. That’s the same amount of money Congress approved last week to fund the entire federal budget through September!

Things appear to be pretty good these days in the economy: Unemployment just hit a ten-year low, while the stock market is doing quite well. And with somewhat improved personal finances, Americans appear ready to get into new cars and homes and, maybe, start more small businesses — most likely, with loans from their banks.

That kind of lending is one of the key factors in a forward-moving economy. When you take out a loan, you allow the bank and the end business, whether it’s a car dealership or a mortgage company, to profit – further stimulating the overall economy. Yet for some reason, banks aren’t aggressively lending money.

Take a look at the chart below. It shows that the largest ten deposit holders have been growing their domestic deposits, but also decreasing lending as a percentage of deposits since 2010. The gap between the blue bars (deposits) and orange bars (loans) in the graph has been expanding over the last six years.

Source: Weiss Ratings

As of 2016, 70% of deposits were given out as loans, totaling $3.87 trillion, with a 30% cash buffer. This $1.66 trillion buffer is the same amount as the entire assets of Bank of America, and well above the Federal Reserve’s required 10% minimum to cover any unexpected withdrawals (The required minimum may be lower for some banks depending on their liability size).

The extra cash that is not given in loans adds to a bank’s liquidity. And a way to identify a bank’s liquidity is to look at the loan-to-deposit ratio, or LDR. It tells us what percentage of deposits has been lent.

If a bank lends 100% of its deposits, it eliminates any cash buffer, exposing itself to major liquidity risks. On the contrary, a low LDR could indicate inefficient cash use, which can reduce bank profitability.

So now that we know what the ratio means, let’s take a look at overall U.S. banking industry trends. The LDR below was calculated using domestic deposit and loan data from all U.S. banks.

Source: Weiss Ratings

The curve shows a decline in average LDR over the last six years. That is another way of showing how banks have reduced lending, leaving themselves with more than just the reserves they’re required to hold.

So why are banks being so conservative? It could be because they lack confidence in their business, and want to hold more of a cushion against any financial problems that could arise. Or it could be that they’re just pickier about granting credit. Ask a small business owner how hard it is to get a bank loan, and you’ll hear that’s the case. Many politicians also argue that excessive regulation has made banks more reluctant to lend.

In any event, increasing interest rates could provide investors with more lucrative investment options elsewhere than plain-vanilla bank deposits. This could lead to slower growth in deposits in the future even as loans continue to grow. This could result in an overall increase in LDR and associated banking system risk.

Bottom line: It appears that banks have extra money laying around and they’re not too eager to lend it out. That could be a good thing, as we want them to be highly liquid to cover any losses or withdrawals.

But they could use some of it more efficiently instead of just sitting on it by reducing their criteria for loan approvals. After all, the economy depends on the growth of small businesses and prudent lending. Striking the right balance is key and hopefully our banks will be able to do that over time.

Think safety,

Remi Lukosiunas

Money and Banking Edition, By Remi Lukosiunas, Financial Analyst Remi Lukosiunas, a Financial Analyst, joined Weiss Ratings in 2014 with a financial services background in internal audit and the credit union industry. Remi conducts banking, credit union, insurance and investment research. He has also written extensively on stocks and investing using ratings as a guide. Remi is a graduate of Florida State University with a degree in multinational business.