Anyone looking for reasons why the economy isn’t growing faster should contemplate the bank earnings that have started to roll in.
Wells Fargo and JPMorgan Chase reported third quarter results on Friday. At both, revenue was lower than the same period in 2012. JPMorgan’s revenue was down 8 percent from a year ago, while Wells Fargo’s fell 3 percent.
Revenue is a good indicator of the underlying strength of a bank’s business and the amount of demand for its loans and services. Banks can pull all manner of levers to make their earnings look better in any given quarter, but that is harder with revenue. As a result, when their top line is torpid for long periods, that prompts bigger questions.
Banks play an important role in the economy. When they lend, they help finance spending and investment. They can also do something that other financial entities cannot. When they take in deposits and lend them out, they effectively create new money. That out-of-thin-air credit is usually a driving force in the economy.
After two of the recessions in the past couple of decades, banks picked themselves up and helped fuel economic growth by piling into new business. Wells Fargo was one of those banks. In the four years after the 1990-91 recession, its revenue on average grew by 15 percent a year. In the four years after the 2001 slowdown, the bank on average posted 13 percent growth in revenue. Since 2009, the bank’s revenues have actually shrunk by about 1 percent a year on average.
There are plenty of reasons for the sluggishness.
Banks are sensibly avoiding some of the riskier types of loans that got them into trouble. They typically don’t hold onto the mortgages they make, but sell them into the market with a government guarantee of repayment. This generates financial gains, but those gains have fallen off as interest rates have risen this year. In addition, management may be distracted by legal problems, and new rules may make it harder to reap profits from certain types of lending and trading. Inefficiencies within banks may also be holding them back.
But a major reason for the tepid revenue is low interest rates.
Since the 2008 financial crisis, the Federal Reserve has tried to keep interest rates at record lows. In theory, this should motivate consumers and companies to take on more debt. But many thought they already had too much. So even with the incentive of rock-bottom rates, they are reluctant to add to their debt.
At the same time, with interest rates so low, banks have earned less interest on the loans they do make, crimping a major source of profits.
It’s hard to see an easy road out. Higher interest rates might boost lending profits at the banks. But the Fed shows every intention of keeping rates as low as possible to stimulate the economy. And while higher rates could increase lending income for the banks, at least initially, more expensive borrowing could also stall the economy and lead to higher defaults.
Effectively, a virtuous circle is needed to lift the economy out of its funk. People and companies have to want to borrow more. Banks then have to be comfortable lending to them at low rates. As this promotes economic growth, the Fed can let rates rise, which would bolster banks’ lending profits. The banks would then make even more loans, further fueling growth.
That is how the economy turned around before. But the banks’ weak revenues suggest such an outcome is still a long way off.
