Low yields have turned the global banking system upside down. Despite the proliferation of generously low interest rates, banks aren’t benefiting. This is largely due to a widespread reluctance among borrowers to take on more debt. US mortgages outstanding, for example, the largest component of household debt, has expanded at a tepid 2.5 per cent annualized rate over the last five years, shrinking as a share of GDP. Home equity loan balances have contracted 5 per cent annually in the interim. While student loan balances have expanded 6 per cent per year since 2014, that market is dominated by the federal government.

Despite global central banks’ best efforts, monetary velocity – aka the “money multiplier”: the number of times a dollar circulates through the banking system annually – has collapsed since the financial crisis, as borrowing has stagnated. Before the financial crisis, monetary velocity was between 2.5 and 4.0. It has been below one since December 2009; we now estimate it to be 0.9. The inability of central banks to stimulate borrowing with low rates is the definition of “pushing on a string.”

Another reason why banks aren’t reaping the benefits of low rates is because global yield curves are flat and frequently inverted, meaning that longer-term rates aren’t meaningfully higher than shorter-term rates; in some cases, they’re actually lower than shorter-term rates. That means that banks’ net interest margin – the yield differential between borrowing and lending – has shrunk, leaving them less profitable.

Germany’s Deutsche Bank personifies that pain. The company, in an effort to retrench, last week announced massive job cuts. Over the past year the value of Deutsche Bank stock has fallen by one third; its price-to-book ratio is an astonishing 0.2. While the German bank’s woes are particularly acute, money center banks face similar environmental headwinds. The S&P Banking Index has underperformed the S&P 500 by nearly 20 percentage points since the beginning of 2018, reflecting the erosion of the industry’s net interest margin. Unless lending conditions improve, expect to see continued underperformance of bank stocks.

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