GFC has led to US banks hoarding cash
The move by banks to hoard excessive amounts of money since the Global Financial Crisis hit, is creating an economic "house of cards" leaving the world's fiscal future teetering on the edge of another downfall, according to QUT economist Jason Park.
Dr Park, who completed his PhD with QUT's Business School, studied the US banking and credit markets during the GFC and found the role of banks in insuring liquidity had vastly diminished and was being taken over by the money market.
"The whole economy is built on the banking system, whereby banks are supposed to be the centre of our economy and charged with taking deposits and making loans," Dr Park said.
"It is this liquidity that makes the world go round.
"But what we have seen and what we continue to see is banks who have survived the GFC, hoard excessive amounts of reserves and liquid assets and this has led to a shift in the money market regime."
Dr Park said banks were hoarding reserves either for stability so they don't go bankrupt, or for opportunistic purposes to benefit from potential fire-sale purchases.
He said the GFC, which was widely considered to be the worst financial crisis since the Great Depression, had seen the collapse and bailout of large financial institutions, liquidity contraction in the credit markets and the banking system, and liquidity infusion by the US Federal Reserve.
"During a period of market stress, banks are uniquely able to provide liquidity to corporate borrowers, while experiencing funding inflows," he said.
"However, with so many US banks in deep trouble during the GFC, this equilibrium where banks act as intermediaries between borrowers and lenders has diminished."
Dr Park said in the absence of banks acting as the centre for risk absorption and redistribution, the money market funds acted as de facto intermediaries by directing withdrawn funds from the banking system to the repo market for safety and liquidity reasons.
"An important implication of this finding is that the specialness of banks in providing liquidity insurance has dissipated after the GFC, as their traditional intermediary role was taken over by the money market," he said.
"This in turn saw the money offered to the repo market reach an unprecedented level by the end of 2008 and has not fallen since, suggesting that banks are either still undergoing a crisis or anticipating another one soon."
Dr Park said the danger to the economy was that the current excessively high levels of reserves and liquid assets in banks' balance sheet, implied that if there was another crisis and the US Federal Reserve once again attempted to infuse liquidity into the banking system, banks were unlikely to act as the risk-absorption and redistribution centre and might instead continue to build up reserves.
"The results of my study show that the US Federal Reserve's intervention in the money markets via the repo market was effective, however, the shift in the money market regime means if another similar catastrophic event was to occur, such intervention would unlikely work again.
"This therefore leads us to conclude that the US Federal Reserve's policy of market intervention needs reconsideration."
Dr Park believes the US Federal Reserve would be best served by an incentivised monetary policy, one where lending rewards were offered rather than an infusion of liquid assets.
"Regulation is not the answer, reward and incentive will encourage banks to release their liquidity - and that will benefit the economy," he said.
- Sandra Hutchinson, QUT media officer, 07 3138 0358 (Tues-Wed) or email@example.com (Mon-Fri)
- Rose Trapnell, QUT team leader, 07 3138 2361