The ECB data do not support the view that European banks are moving cash assets out of Europe and into the U.S.: it the Fed's QE2, that's all
Monday, September 5, 2011
Update: I modified this post since original publishing. I am sorry for that; but I came to some broader conclusions.
Kash Mansori published complimentary articles that received quite a bit of attention in the blogosphere. Using data published by the ECB and the Fed, Kash Mansori argued (here and then here) the following:
monetary financial institutions (MFIs) in Europe have been moving their deposits out of European banks. Where is that money going?
It looks like much of it is being placed with US banks instead. The following chart shows the total deposits at domestically chartered commercial banks in the US.
Clearly, something is going on -- the recent rise in deposits with US banks has been dramatic, with an above-trend increase in deposits of approximately $500 billion over the past 6 months.
I have a pretty simple problem with this analysis - the two posts span two different time periods, 1.5 years and 6 months.
In this post, Kash argues that deposits of monetary financial institutions (MFIs) with other MFIs declined by € 461 billion spanning the period January 2010 to July 2011 (using freely available ECB data), implying that they must be moving their cash somewhere else (bolded by yours truly):
with an above-trend increase in deposits of approximately $500 billion over the past 6 months.Rebecca: The problem is, that spanning the last six months MFI deposits with other MFIs (in Europe) has INCREASED by € 26.3 billion (see Table below).
Who is responsible for this sudden inflow of deposits into the US banking system? The answer is non-US banks, as illustrated in the following picture, which shows the cash assets of domestically chartered banks alongside the cash assets of foreign-owned banks in the US.
Therefore, the 6-month increase in deposits and cash assets in foreign-related U.S. bank branches cannot be related to outflows in inter-MFI deposits in Europe. Yes "something else is going on".
In this post, I argued pretty simply that the ECB data on MFI (monetary financial institutions) deposits do not demonstrate that European banks are decreasing their cash holdings in Europe for the U.S. safe haven over the last six months. Therefore, the recent surge in the cash assets of foreign-related banks in the U.S. is not related to recent financial turmoil in Europe.
But why, nevertheless, has there been a surge in the cash assets of foreign-related banking institutions in the U.S. (i.e., Deutsche Bank offices located in the U.S., for example) since November 2010? There are two reasons, in my view. First, the surge in assets correlates perfectly with the outset of the Fed's second round of quantitative easing. But the surge in cash assets also correlates with increased net liabilities to foreign branches (illustrated below). In short: foreign banking institutions received easing reserves from the Fed AND sought the profit potential of a very steep U.S. yield curve.
The second round of the Fed's quantitative easing program started November 2010. As illustrated below, a surge in the cash assets of foreign-related U.S. bank branches is starkly coincident with the outset of QE2 (Fed vault cash and reserves is filed under 'cash assets' in the H.8 Tables).
I cannot answer with certainty why cash assets of foreign-related US branches surged relative to the domestically chartered banks, since the level of detail is not so granular. However, I suspect that it has something to do with foreign banks making a conscious decision to transfer capital into their increasingly profitable U.S. branches.
Regarding foreign bank capital flows, the evidence of capital flows among foreign bank institutions and their U.S. branches is not in the ECB data, it's in the Fed's H.8 Table, pages 8 and 19, line 40. Line 40 shows that foreign-related bank branches in the U.S. increased their net-liabilities to offices located outside of the U.S. rather precipitously since November 2010. Better put: the head office diverted funds away from offices outside the U.S. and into affiliates within the U.S.
The chart illustrates net-foreign liabilities for both U.S. domestically chartered banks (red line) and foreign-related banks in the U.S. (blue line). For the foreign-related institutions with U.S. branches, a negative liability is effectively an asset or claim on its branches located outside the U.S. On the other hand, a positive number is a net liability, or the U.S. branch owes the foreign branch.
Net liabilities by foreign-related bank branches in the U.S. have risen sharply to branches outside the U.S. Not coincidentally, the series bottomed in November 2010, the month when the Fed initiated QE2. Since then, foreign-related banks increased net-liabilities to their local counterparts outside the U.S. by roughly $515 billion. In June 2011, the net liabilities to foreign branches by the foreign-related banks in the U.S. turned positive.
The head offices of foreign banking institutions are diverting capital to their U.S. branches relative to other foreign branches. Why would they do this? The yield curve is steep - and in banking world, a steep yield curve is highly profitable. The Fed's announcement of QE2 in November 2010 made funding in the U.S. very cheap, an input to bank earnings.
No ulterior motive - just profit seeking.