One possible other perspective is, if loan demand is weak even though rates are so low, then rates aren’t low enough. It comes down to simple carry trade economics, the rate of return must > cost of carry.

Put another way, businesses will not borrow to invest if they do not believe that they can earn a rate of return on their investment which is higher than the interest rate on the loan.

What is interesting about this perspective is that it allows us to see that low rates are much more than a function of central bank policy – they are a boots on the ground reflection of the lack of future growth.  

However, this point of view is still limited as it only considers one dimension of the problem, demand, and neglects the other – supply.

But why would banks be complaining about tepid loan demand if supply was an issue?

Simple, because loan demand is tepid within the segment of the consumer/business population that banks are willing to lend to. In other words, the number of businesses/consumers that banks deem to be creditworthy enough to lend to is smaller than it was before.

This makes sense because banks do not exist in a vacuum, they exist in the same economic ecosystem as their clients, the businesses and consumers who bank with them.

This means that if businesses aren’t borrowing because of their concern over future growth prospects, banks aren’t going to be willing to lend for the same reason. Banks are businesses too, and they must manage the level of risk they are taking in relation to the broader economic environment, lest defaults blow up their balance sheets. 

Of course, this unwillingness to lend does not extend to the entire population, and banks are still willing to lend to some clients, but only the most creditworthy ones. However, the most creditworthy clients are also the ones who have the least need for loans.

This is because they already have plenty of capital – it’s why they’re considered to be the most creditworthy in the first place! In response, banks slash the rates they offer to these clients, causing interest rates to fall even further.

Consequently, access to bank lending becomes bifurcated, with those who don’t need it having cheap and plentiful access, while those who do remain locked out.

Ultimately, loan growth and the interest rates that follow come down to basic economic behavior of both the clients who demand it, and banks who supply it.

Both sides look to take care of their own interests, leading to market outcomes which are counterintuitive and opposite to what we all learned in school, but remain logical.

That’s why it’s called the interest rate fallacy, and all that is required to understand it is a change in perspective!