Is Bank Competition Really a Good Thing?

Truthfully, I’ve had to question everything. No stone on the surface of modern capitalism has been left unturned.

That got me to this question: Is bank competition really a good thing – or would fewer banks equate to more realistic pricing and therefore more reserves (and less net loss) every time an economic Armageddon comes around?

“If loan officers at my hometown bank won’t prostrate themselves to a 3% spread, there’s a lender somewhere else that will.”

I mean, who ever said a car loan should be anything under 20%? What ever happened to waiting to buy the car until you actually had earned (and saved) the cash to do it with?

Does the “reward” of a 6% car loan really have any relationship to the risk anymore of not getting paid back? How safe a financial industry model you can really build on a three (or under) point spread? Apparently, not one that’s safe enough.

But why is spread three points to begin with? Largely because if loan officers at my hometown bank won’t prostrate themselves to rate, there’s a lender somewhere else that will (probably around the corner at this point, or at least back when there was any credit to lend in the first place). And so the cycle begins; a good loan, set at a rate supposedly commensurate with real risk, turns into a time bomb.

That will – and I fear unfortunately has – gone off.

Will market competition ever allow real risk assessment in lending? And who ends up paying for the “under-market” rates in the end? We do in the form of TARP, TALF (and who knows what other four letter combinations are down the road waiting).

The metrics don’t quite add up. That’s because a spread of 3% (or under) leads to a return on assets of 1% (or under), which in turn means that banks can’t grow their capital base in a way that is consistent with the risk they are piling onto balance sheets. This leads me to the seemingly preposterous conclusion that banks ought to be lending money at something like 27% interest. Of course a number like that extracts an outrageous toll on borrowers, who pass the high cost of financing onto their customers, making the pain go even further and wider.

But then - it’s not like these same customers aren’t already getting a wallop in the form of perhaps another trillion (or more) on the national debt and the associated interest and taxes.

It gets down to the old “pay me now or pay me later” scenario. Frankly, I would have rather paid the up front costs associated with 27% (or whatever turns out to be “real”) interest rates from companies I’m doing business with in some form or another. As it stands now, it looks like I’ll be paying for all the lenders across the fruited plains who didn’t charge enough interest on their loans, which de facto, means every single one of them.

So if we want access to credit, make sure there is credit to access. Making it cheap may feel good for a few decades, but sooner or later, it gets expensive – apparently, very expensive and very fast. Maybe instead of caps on deposits (remember the 70’s? Take a look at the chart for “disintermediation and deposit rate ceilings” below) we need to set floors on loans.

Maybe the one metric the government needs to set is the “base rate of risk”. Anything above the base rate stays a private sector decision. Nationalize risk or nationalize banking; either way, someone has to start writing checks because the system is out of balance and out of control. The days of giving away cheap money without concern for what’s coming after are officially over.