The Bifurcation Of The Credit Market
Do low interest rates exacerbate inequality? Most who answer intuitively would say no, since low rates mean that borrowing is cheaper across the board. Except that it isn’t across the board.
Loans made to high net worth clients are representing larger and larger percentages of banks’ loan portfolios. Taking a look at recent data from three of the largest American banks, JPMorgan, Citi, and Bank of America, we can see that this is true for the years of 2019, and 2020.
Over the course of Pandemic 2020, banks increased the amounts they lent to their wealthy clients, and reduced it for others. The chart below only shows a small data set of High Net Worth (HNW) and non HNW lending; per FT reporting and data, this trend has been going for much longer than the last 2 years.
However, before we rush to criticize banks for doing so, it is important to understand just why they are doing so.
Simply put, they are doing what well managed banks are supposed to do – manage risk. Wealthy clients, by virtue of being wealthy, are considered to be more creditworthy than less wealthy clients. Also, wealthy clients tend to borrow larger amounts, which means that banks can earn more interest income while taking on less risk of default. Of course, if the rich clients default, the bank is on the hook for large losses too.
All of which is perfectly logical and reasonable behavior for profit seeking corporations who must answer to both shareholders and regulators. With the former, banks must maximize risk adjusted returns; and with the latter, they must comply with existing risk management regulations.
But, what does having a preference for lending to rich clients have to do with low rates? The answer to this question lies in the interest rate fallacy, where rates are low because the borrowers don’t need to borrow – they are already wealthy. The only way banks can compete against each other to make more loans to more wealthy clients is by making the loans cheaper and cheaper. But cheaper only for a segment of the population, the wealthy.
The result of which is the bifurcation of the credit market, where those with capital can get easy access to even more capital, and those without, can’t. This naturally means that those who are locked out of, or have to struggle greatly to secure bank loans, are locked out of participating in markets which could possibly help them to generate wealth, like US housing. This reinforces the rich-get-richer dynamic, which by extension also reinforces the poor-stay-poor one.
Who is to blame for all of this? The vast majority would point towards the Federal Reserve, or central banks in general, for keeping interest rates so low. Unfortunately, while central banks make convenient scapegoats for our economic ills, they aren’t responsible for low rates, because they do not control rates to begin with.
What central banks can be blamed for is misunderstanding the financial system they are supposed to oversee. Their single minded focus on using bank reserves as a policy tool, even though bank reserves have nothing to do with money creation, has rendered them unable to see the real problem. That is, the lack of, and by US bank’s own lending data, worsening, access to credit!
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