A December 1st report from Liberty Street Economics highlights that banks that are seeing increased deposits due to the ongoing fracking boom are lending out very little of their growing cash hoard. Liberty Street’s Matthew Plosser points out that banks in fracking boom areas are converting about 75% of their additional deposit funds into short-term investments and only loaning out around 25%.
Plosser writes that his project “shows how the development of new energy resources has led to deposit inflows to banks and how that can be used to estimate banks’ investment decisions over the recent business cycle.”
Fracking leads to large royalty payments to local landowners
Michael Mauboussin Tips From Great Investors [Pt.2]
This is the second part of a short series on Michael J. Mauboussin's research document reflecting on 30 years of Wall Street analysis published in 2016. Q3 2020 hedge fund letters, conferences and more The document outlined Mauboussin's observations of successful investors throughout his three decades on the Street. This article starts at point six. Read More
The first point Plosser makes is that banks end up seeing very significant deposit growth in fracking boom areas. He created a chart to illustrate the average changes in payments and deposit growth as the energy development ramps up. In the chart, year 0 represents the initial year of drilling. County-level deposit growth is calculated relative to the growth neighboring counties. Before the fracking boom in these area, excess deposit growth is approximately zero, but after fracking starts, excess deposit growth becomes consistently positive. Plosser notes that deposit levels were up on average 40% on average seven years into development
Banks only loaning out a quarter of their fracking windfall
Plosser points out that banks have three methods of allocating new funds on their balance sheet: making loans, investing in liquid assets such as cash or short-term securities, or they can pay down existing financing.
In this study, however, banks chose to put more than three-quarters of the additional funds into extremely low-interest-rate liquid assets and only deploy a quarter into new loans. Plosser notes: “Over the entire sample, 2003-12, I estimate approximately 25 percent of these deposit inflows are allocated to lending and 75 percent to liquid assets.”
Impact of 2008-2010 recession on bank lending practices
Plosser notes that before the financial crisis, banks on average invested around 40% of their incremental deposits increases in loans. However, as the crisis deepened, banks began investing a larger and larger amount of deposit inflows into liquid assets and reducing the amount of loans. Of note, allocations to liquid assets peaked between 2009-11, with close to 85% of new deposit funds allocated to cash or short-term securities.
He points out that bank behavior obviously changed in response to the financial crisis, with banks “less able or less willing” to allocate as much to loan activity as they were prior to the crisis and ensuing recession.