Wednesday, March 28, 2012

Banks Dominate Euro Area Lending because of the Low Ratio of Short Maturity Government Debt?

The full mechanics of money supply endogeneity seem to be one of the remaining mysteries of macroeconomics. As I have explored for a couple years now (see for example the most recent two posts, A Visual Guide to Endogenous Money and the Failure of QE and Kaldor on Money Supply Endogeneity) there appears to be a truly remarkable layer of money supply dynamism that even most modern Post Keynesians fail to discuss. (And the mainstream of course remains hopelessly unaware, stuck on inapplicable theories like IS/LM that treat financial assets like commodities!)

Consider this chart showing the ratio of Bank versus Non-Bank Lending in the Euro Area versus the United States * (source: ECB Monthly Bulletin via Alea):

I've seen this difference referred to on occasion over the years, but I've never seen anyone attempt to ask or answer, "why the difference?"

I believe the reason is that the US government issues a much greater proportion of its debt as short duration (less than one year) as compared to the Euro Area governments, who rely much more heavily on longer duration debt:

Percentage of Euro Area Debt Maturing within One Year, by Nation, 2010 (Source: Eurostat)

Percentage of US Treasury Debt Maturing within One Year (source: The Economist):

Based on the charts above, the Euro Area countries seemed to average roughly 10% short duration debt (maturing within one year) and 90% long duration debt in 2009. The US government on the other hand has issued short duration debt much more heavily -- ranging from around 30% to around 45% of total treasury debt outstanding in the years leading up to 2009. (Unfortunately I couldn't find charts with dates or date ranges that exactly matched between the US and Euro Area).

As I explained in earlier posts on money supply endogeneity, banks seem to operate as a "lender of last resort" within the private sector. If there is a temporary "excess" of people who hold short duration assets (such as bank deposits -- i.e., money -- and short duration government debt which acts a lot like "money"), then these people will be more eager to lend (aka "invest", likely through an intermediary), thus transforming those short duration assets into long duration assets (debt assets). However, without that temporary "excess" of short duration assets, banks can always step in as the "lender of last resort", since bank loans create money. Thus any temporary "shortage" of desired short duration assets within aggregated private sector portfolios will disappear as the bank loans increase the money supply! These mechanics are covered in more detail at the previous posts linked to in the first paragraph.

(You can use this visualizer to compare bank lending, bond issuance, etc).

Bottom line: the private sector has to accept the maturity profile of the assets supplied to it by government (government debt satisfies savings desires), and builds upon that "starting point" to get to an aggregate desired portfolio maturity profile. In the Euro Area, it appears that this starting point includes "not enough" short duration assets, so to satisfy borrowing needs (note: borrowing needs are an independent dynamic from portfolio preferences), the private sector relies heavily on bank loans. But in the US, the "starting point" given by government already includes a larger proportion of short duration assets, so borrowing needs are filled using a larger ratio of non-bank lending, since non-bank lending changes the portfolio mix in a way that doesn't increase the percentage of short duration assets outstanding.

And as I've suggested before, if the US government embarked on a truly massive shock and awe style QE (many trillions of dollars of additional asset purchases) as proposed by Paul Krugman and perhaps others, it might inadvertently "kill" a lot of the US banking system, or at least kill off much of banking's traditional on-balance-sheet lending function. (Banks might still earn fees from originating loans before selling them to non-banks, and non-banks could also originate lending as they do now). And along similar lines, when MMTers sometimes suggest that the US government should not issue bonds at all, I wonder whether they are aware of the possible impacts on the banking system. Just to be clear, I'm not expressing an opinion on whether such a change would be good or bad, I am just pointing out that the system might be different in large and unpredicted ways.

* DISCLAIMER: The first chart only shows "External Financing for Non-Financial Corporations," so a chart that also included household borrowing might tell a very different story that could contradict the analysis in this post. It seems improbable to me that there is a massive reliance by European households on non-bank lending that would be large enough to offset the corporate reliance on bank lending, but I'd be glad to hear if I'm wrong.

UPDATE 2:21pm:
, I realize I failed to discuss how the propensity of US households toward bank borrowing versus non-bank borrowing (of unknown amount) could change the premise I introduced with the first chart by making the Euro Area and US look more alike when considering the entire private sector's borrowing rather than just corporate borrowing.
Second, the title read as more definitive than I originally intended, so I added a question mark -- this blog post's content (statements often prefixed by "I believe...") is still largely speculative, though there seems to be supporting evidence in the Circuitist literature (as I interpret it).


  1. I would not draw such far reaching conclusions. I believe the reasons for differences are purely cultural. They range from penetration of securities market into retail segment to the excess of cross-border banks over cross-border companies. Europe is a completely different animal from the US. Its reliance on banks is historical.

    The point about maturities is an interesting one but it does not illuminate anything about the saving desires. As other MMR/MMT debates show the saving desire comes mainly from households. In Europe it is intermediated by banks. In the US these probably are money market and mutual funds. That is it.


    1. Thanks for commenting! I think I agree my conclusions did over-reach, but I still consider them plausible possibilities, even if there might be other explanations for the differences, as you say. At some point I'll try to create a clearer visual depiction of why this might be a plausible explanation.

      Good point about the combination of cultural differences AND a potentially higher reliance within the US on money market funds and the like. Looking at the right mix of data including money markets and other non-bank short duration assets could be sufficient to completely invalidate my conclusions... It would be interesting to compare quantities in more detail to find out, though I'm not up for that much digging in the data right now (maybe one day!)

  2. I am not an economic expert, so forgive my ignorance in advance if I say something stupid:) However, as a Brit, I think one advantage we have is the average length of our government debt (Gilts) is substantially higher than that in the UK, meaning the Treasury has locked in low yields for quite awhile longer. At least, this is what I have read in a couple of places.