It’s the liabilities, stupid January 11, 2014 at 11:15 am
Banks are almost always and everywhere largely deposit financed…
The asset side of banks’ balance sheets – and, in particular, their mix of loans versus securities – is considerably more heterogeneous… One interpretation of this is as follows: While lending is obviously very important for a majority of banks, it need not be the case that a bank’s scale is pinned down by the nature of its lending opportunities. Rather, at least in some cases, it seems that a bank’s size is determined by its deposit franchise, and that, taking these deposits as given, its problem then becomes one of how best to invest them.
Within the category of [banks’ investments in] securities, they appear to have well-defined preferences… it looks as if banks are purposefully taking on some mix of duration, credit, and prepayment exposure in order to earn a spread relative to Treasury bills.
With these liability-centric spectacles on, banking is a business of (1) attracting deposits and (2) figuring out something to do with them that reliably earns a spread to their cost. Credit extension is a consequence of this activity, not a core part of banks’ business model.