Over the weekend, the Financial Times (and ZeroHedge) reported the following:
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.
This will not come as a shock to those who remember when Bloomberg reported that BNY Mellon began charging customers with over $50 million in their accounts 0.13% on the ‘excess’ in August of 2011. With interest rates held below the ‘natural’ rate by the Federal Reserve, banks had few opportunities to profit from holding large deposits – especially due to high costs of insuring those deposits.
Deposits are a double-edged sword for banks. On the one hand, banks need a source of deposits in order to operate in a fractional reserve system. (Although through FRB Regulation D, banks have been able to transparently reclassify customer accounts to achieve lower reserve requirements.) On the other hand, banking only works if revenues (e.g. interest from good loans) exceed costs (e.g. bad loans, deposit insurance, systems, branches).
For reference, the Federal Reserve began paying interest (0.25%) on excess reserves (those are reserves in excess of requirements) on October 6, 2008. Excess reserves had been nominally $0 but have increased to $2.3 TRILLION 5 years hence. One question I have been unable to answer is what assets actually compose these reserves.
While wealth inequality has increased due to market intervention following the financial crisis of 2007-2008, this development would only worsen the picture. Charging for deposits would act as a regressive tax because the wealthy hold a lower percentage of their net worth in such accounts.
To the common man who exchanges his time for money, his deposits are the only source of legitimacy inherent in the banking system. He may have some idea that he is marginal compared against the big players managing their wealth generated from financialization or proximity to the government trough. The political and societal risk from undermining this legitimacy cannot be overstated.
In such an environment one might see bank runs as depositors rush to withdraw hard money, or convert to alternative currencies (RMB, BTC) and/or precious metals. Not only would this shock the financial system, it could decrease productivity as people would rather line up at the bank or stay home with their money to avert theft.
Aside on Interest Rates
Generally speaking, the ‘natural’ rate of interest is unknowable due to market intervention. With bank customers flocking to deposit accounts, however; returns to capital should have increased. Instead they decreased as the government stepped in to offer alternative investment capital. So although unknowable, one can argue that the natural rate was above the nominal rate.
Aside on Deposit Insurance
Deposit insurance is a flawed mechanism used to socialize banking losses to all depositors. Without deposit insurance, depositors at failed institutions may lose everything. With deposit insurance, this risk of failure is transferred to another party, in theory. In practice, this leads to increased risk-taking by insured parties and eventual systemic collapse — as observed in 1989 when the Savings and Loan Crisis bankrupted the Federal Savings and Loan Insurance Corporation (FSLIC). Through slight of hand, the FDIC absorbed FSLIC’s responsibilities and was nearly wiped out in the Great Recession. Given that both the cost of deposit insurance and systemic failure is passed on to society at large, one might conclude that allowing individual institutional failure represents a lower total cost to society.
Incidentally, the FDIC was created to be a temporary government corporation in 1933, but was made permanent in 1935.