The Changing Face of Big Banking In the past, banks used to lend to businesses which invested in and built up communities. That has changed substantially. The face of banking, at least for the big banks, has shifted substantially, especially with the de minimus and too irrelevant regulation they face. JP Morgan Chase is typical and cutting edge. JPMorgan Chase is the biggest bank in the U.S., as measured by deposits. However, it has been doing less and less of the typical kind of lending that supports economic growth. And the shift in its business stratagem has caused its profitability to have soared. In 2008, the bank lent out just under 75 cents for every dollar of deposits it took in. It is now lending out 56 cents on the dollar, a big drop. So what is the bank doing? While JPMorgans deposits have ballooned, the growing and most profitable investments for it to make with those deposits are not loans, but instead mostly in selling derivatives of one or another kind, typically credit derivatives. In fact, with interest rates as low as they are, more conventional lending would just mean lower bank profits. The big banks have been driven out of conventional business lending by the Feds low or no interest rate policies and substantially into the derivative markets. This is very problematic and exposes our banking system to horrendous systemic risk. Here is why. Most derivatives are single instrument (a single loan) insurance policies sold for a price by the bank that guarantees the purchaser, usually a creditor, repayment of principal, but sometimes interest too. The problem is no reserves or contingency funds are held by the banks against such derivatives at all. In good times, any losses are basically covered from operating revenues. In a crash, banks can drown in a sea of claims and become quickly insolvent, as occurred on Wall Street after the crash of 2008 but before the big bailouts, especially of AIG. The reason derivatives are so profitable is precisely because there are no reserves or contingency funds held aside to cover their losses. It is a sort of protection racket that earns money and is essentially costless. The world market for derivatives at face value is estimated to be $1.2 quadrillion or about 20 times the GDP of all the nations in the world. This market is huge and mega dangerous. The derivatives market is also complex and I simplify it much here for the sake of exposition. It is also unregulated. This it ought to be of major concern to world leaders, but it really isnt. Too many people simply dont understand derivatives or their risk. Banks love them precisely because they are so profitable and unregulated even though the financial crash of 2008 taught us how problematic they can be for anyone paying attention to what happened to AIG. We are playing with fire here . . . Big Time. And we are also asleep at the wheel.
Posted on: Wed, 12 Nov 2014 23:37:00 +0000
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