Today Justin is out doing what in the news business we call “reporting.” He graciously suggested I take the relative radio silence to promote some stories I’ve recently written for Time.com. Seems I’ve fallen behind on the self-promotion. To right that wrong, let me draw your attention to a piece I wrote earlier this week about how banks are fighting for consumer deposits—and hurting themselves in the process. It starts:
Beleaguered financial institutions looking to shore up their funding are battling for your deposit dollars, driving interest rates on bank products abnormally high. At first glance, that’s fantastic news for consumers who are finding CDs that yield 4% and money-market accounts that pay 3%. But the competition for money — which will surely intensify as new bank holding companies like Morgan Stanley, Goldman Sachs and American Express amp up efforts to attract deposits — is also squeezing banks’ profit margins, further straining an already weak industry and stressing smaller banks, many of which didn’t go hog wild making risky loans in the first place. “Higher rates are a short-term fix,” says Camden Fine, president and CEO of the Independent Community Bankers of America. “Eventually, you feel the aftereffects.”
Here’s one way to think about those aftereffects: the average yield on a one-year CD is 2.39%, the same as it was in mid-August, even though the prime rate — the rate at which banks lend to their most creditworthy customers — has fallen from 5% to 4%. That means a bank that used to borrow at about 2.5% and lend at 5% now borrows at 2.5% and lends at 4% — an entire percentage point has been stripped from the bank’s ability to make money. More than half of all banks saw their net interest margin — a measure of profit — fall in the third quarter compared with a year ago. To read the full story and see where I’m getting those numbers from, go here.
A very smart friend of mine, hearing me talk about this, asked why banks wouldn’t simply charge more for loans in order to make up the gap. Aren’t consumers and businesses supposed to be starved for credit? I asked Timothy Koch, a professor of banking and finance at the University of South Carolina’s Moore School of Business, about this. He said that while it is true that banks can charge more for loans, that pricing power hasn’t proven great enough to completely undo the profit margin squeeze. Keep in mind that banks are still nervous about lending to anyone without a top-tier credit score.
Then there is the fact that banks often make money not buy borrowing and lending, but by borrowing and investing. That process has really gotten gummed up. Mike Menzies, who is president and CEO of Easton Bank & Trust on Maryland’s scenic and friendly Eastern Shore, gave me a great example. He recently lost a bid to get $5 million in cash from a local government in exchange for the bank’s issuing the government a one-year CD. The winning bidder agreed to pay the government 3.72%. Menzies had offered 2.69%. He thought he was offering a pretty high rate—he was only planning to net 4 or 5 basis points of profit after rolling the money into an investment like a Fannie Mae mortgage-backed security.
So how could someone else offer a higher rate? Let me continue to crib from my story in block-quote form:
Chances are, the bidder wasn’t looking to make a profit — just trying to inject liquidity into the institution’s balance sheet — or was pursuing riskier investments in order to make the transaction make sense. “When a bank chases yield, they then start making riskier investments or riskier loans,” says Fine of the Independent Community Bankers of America.
That’s probably not something we need more of right now.
Barbara!