THE DEEPER REASON FOR BANKING´S RETREAT / THE ECONOMIST

Credit creators

The deeper reason for banking’s retreat

Why bankers no longer play golf at 3pm

Illustration: Alberto Miranda

In an earnings call on July 15th, Jamie Dimon, the boss of JPMorgan Chase, made a familiar complaint. 

He rattled off a litany of burdensome, overlapping regulations: “SLR, G-SIFI, CCAR, Basel III, FSRT”. 

He then called on regulators to draw “a deep breath”, step back and take stock. 

Reform was necessary, he said, to “create more liquidity, more loans and a safer system.”

Many people share his frustration. 

They argue that large commercial banks have been hobbled by regulatory red tape in the aftermath of the global financial crisis of 2007-09. 

As a regrettable but predictable consequence, these giants have pulled back from lending. 

That has left a vacuum increasingly filled by fintech upstarts and private credit—funds lent by asset managers, not banks.

This story is not entirely wrong. 

But it misses a longer arc in the history of credit. 

Since the 1960s direct lending by banks to firms and households has steadily declined. 

This shift began decades before the financial crisis and reflects deeper forces than overzealous regulation. 

Much of what is now blamed on recent policies is simply part of this slower-moving retreat.

To understand this transformation, recall the traditional banking model, popularised in movies like “It’s a Wonderful Life”. 

Banks accepted deposits, promising to redeem them on demand, with interest. 

They lent to firms and households in the form of mortgages, small-business loans and consumer credit. 

The bank’s job was clear: safeguard deposits, evaluate creditworthiness and monitor borrowers. 

The path to profits was straightforward, too. 

Banks earned the spread between what they paid their depositors and what they earned on loans. 

People would joke about the “3-6-3 rule”: borrow at 3%, lend at 6%, hit the golf course by 3pm.

Tee-bonds

The mid-afternoon golfers once ruled the world of credit. 

In 1974 nearly 55% of private lending in America was held on banks’ balance-sheets as direct loans. 

But that world had disappeared well before the financial crisis struck. 

By the beginning of this century, this form of credit accounted for less than 35% of private lending, where its share remains to this day (see chart 1).

In place of the traditional bank loan is a growing stack of debt-linked securities. 

These include mortgage-backed bonds, corporate paper and loans to private-credit firms. 

Banks still collect deposits from households and most still originate loans. 

But instead of holding these credits on their balance-sheet, they sell them on, while buying slices of securities at market prices from other lenders.

In doing so, they have gradually ceded the role of credit provision to others. 

Even as banks’ size in the economy has grown—their assets have risen from 60% of GDP in 1960 to 94% today—their contribution to lending has stayed flat, at around half (see chart 2).

Households and firms instead borrow from a litany of other lenders and guarantors who package and sell the debt to banks. 

Big companies have increasingly switched to public bond markets for debt financing. 

Small businesses have turned to fintech and online lenders. 

Buy-out firms have turned to private credit. 

Households still rely on banks for mortgages, but these sit on the banks’ balance-sheets only after being repackaged and securitised by government agencies.

Why the change? 

The kind of regulatory impositions highlighted by Mr Dimon have certainly played a part. 

Recent policy, for example, explains why banks have surrendered much of private-equity lending to other institutions, according to research by Sergey Chernenko of Purdue University and his co-authors. 

Regulators require banks to hold more capital when making direct loans to firms than they do when buying securities backed by similar loans.

But the shift has deeper origins, as documented in research by Greg Buchak of Stanford University and others. 

Technological developments, ranging from securitisation software to FICO scores, led to the development of new financial instruments and alternative securities markets. 

Before 1980 the corporate-bond market was less mature; Fannie Mae, a government-sponsored enterprise, had yet to sell any mortgage-backed securities; and no one needed to understand collateralised loan obligations (which slice up loans and apportion them to investors according to their risk appetites). 

Today such institutions are entrenched parts of the financial system. 

Savers, too, began to act differently. 

They gravitated away from bank deposits towards pensions and money-market funds that channelled their savings into credit markets.

To the characters from “It’s a Wonderful Life”, today’s banks would be a mix of the familiar and the strange. 

Now, as then, banks use deposits to hold debt-related assets. 

And now, as then, creditworthiness matters. 

Losses still hit the balance-sheet whether a household defaults on a mortgage the bank made itself or on one buried in a securitised pool.

But today’s banks are less dominant. 

And it is not just that their lending is taking different, indirect forms. 

Nina Boyarchenko and Leonardo Elias of the New York Fed, who trace credit flows through layers of intermediaries, find that net bank lending to households has fallen by about a quarter over the past 50 years.

Is the bankers’ retreat a bad thing? 

One inconvenient consequence is also faintly ironic. 

In the old days policymakers could keep the financial system stable by policing a finite number of familiar, marble-floored institutions. 

Now, as banks play a smaller role and credit easily migrates elsewhere, policymakers must cast a wider net in their pursuit of financial stability. 

A phenomenon often blamed on regulation may have complicated regulators’ lives.

More happily, banks have become less fragile—less dependent on the unstable alchemy of funding long, opaque, illiquid loans with short, runnable deposits. 

Rather than holding entire portfolios of mortgages, banks can now hold the safer slices of securitised debt, which get paid first when things go wrong. 

The riskier slices can be pushed to investors with longer horizons (such as insurance companies) or greater risk appetite (such as hedge funds). 

Some research suggests that credit booms led by non-bank lenders tend to be less destabilising than other expansions. 

They are associated with a lower risk of GDP crashes than bank-led booms, according to Ms Boyarchenko and Mr Elias.

The transformation of banking also sheds light on the industry’s defining characteristics. 

Academics have long debated whether banking’s edge lies on the liability side of the business (in issuing sticky, low-cost deposits) or on the asset side (in originating, monitoring and collecting loans).

The fact that banks have grown so large, while ceding much of their lending business to others, could help resolve that debate. 

It suggests the secret of their success lies in courting depositors, not marshalling borrowers.

The good news for bankers is that a modern version of the 3-6-3 rule still applies. 

Banks can still borrow cheaply. 

Indeed, they now pay depositors closer to 0.5% rather than the 3% of old. 

They lend, or rather invest, in a broad mix of securities yielding anywhere from 1% to 10%. 

And as for the 3pm tee time? 

That, too, has shifted: Stanford researchers say the most popular midweek golf slot is now 4pm.