Tuesday, April 23, 2019
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Rates are "gifts", but for whom?

To support the economy, monetary authorities keep rates low. This is a poisoned gift for both banks and savers.

By Olivier Myard.

By keeping rates low, central banks are restricting the banks' profitability, which requires high rates to recover satisfactory profitability. The meager profits of banks limit their aid to the economy, hindering growth.

Since 2009, the authorities of developed countries have discovered the philosopher's stone of economic policy, with free money or almost (at least for the rich and the states) for eternity.

Henceforth, no more worry, we can accumulate budget deficits to satisfy the appetites of voters who consider themselves forgotten sharing free money, and go into debt at will without suffering, since the rates are "gifts". A politician's dream!

No wonder the appetites are sharpening and they are more numerous to solicit your votes …

In these circumstances, should we expect an effect " bonanza forever "? Let's spend more Folleville, the bill will never be presented!

Nicolas Perrin recently emphasized all the risks, explosives, that this aberrant situation logically weighs on our economic system. No need to come back.

To all this is added a small grain of sand, from the so-called Basel standards. Because the profits of banks are penalized by the long-term maintenance of low interest rates.

Indeed, international prudential standards require banks to have a minimum ratio of equity to total loans outstanding to their clients (except for loans to sovereign states, for which the rules are more generous …).

As a result, in order to be able to lend more and better meet the demand of their customers, especially for high value-added projects that predict future healthy growth, banks need to increase their capital.

It's mathematical.

To strengthen their own funds, and thus their ability to better finance economic development, banks have only two solutions.

The simplest, the healthiest, is to make enough profits to be able, after dividend distribution, put the remaining net profit in reserve.

But that supposes to have an excellent beneficiary capacity. But the long-term maintenance of low interest rates does not allow banks to accumulate profits at the height of the stakes.

If profits are not high enough to "naturally" strengthen equity, it is still a good old practice. Call on shareholders to participate in a capital increase.

A sign that nothing is better for banks

But shareholders will only do so if they feel they will have a good return on investment in the future. But many European banks quote about half of their equity, unheard of in modern history, masterful sign of investor distrust of the banking sector.

The prospect of low interest rates, if not zero or negative "forever", can not make savers optimistic about banks' profitability. These investors will not be very motivated by a capital increase that either will be a failure or simply will not be tempted.

Admittedly, through the T-LTRO and other QE techniques, central banks make available to commercial banks large loans. These resources are in addition to those obtained through traditional bank financing mechanisms.

However, since the prudential ratios are unchanged, banks' total lending capacities remain capped (except for the sovereign risk of course …) in proportion to the size of their own funds.

In the end, for the individual, it is "face I lose" (bond yields close to zero or zero or negative, penalizing life insurance and retirement plans), or "pile I lose" (economy anemic on the long-term, reducing healthy investment opportunities, unless you are initiated or take the risk of a bubble).

This weakening of the balance sheet of the banks presents a systemic risk and carries the seeds of a collapse of the economy in term and thus of the bursting of the bubbles. The saver can always say "as long as I win, I play" but who can believe that he will be lucid enough to release bubbles in time?

To receive high returns in this low interest rate universe, some may for example look at income generation techniques through the sale of options.

Or investments in international real estate, diversified, in countries where rental income remains high, through funds responsible for management and pooling risks.

For more informations, it's here.

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