A Simple Explanation

Walter Kurtz from Sober Look points out the growing gap between loans and deposits and asks the question of what is driving this divergence. 

Some other commentators have tried to associate this change in growth rates to some nefarious practice by banks, but the reality is that it is mostly an accounting issue related to QE. The explanation is made simpler if you look at the balance sheet operations of the Fed and commercial banks under QE programs. 

From Soberlook:

"... The last one however is particularly intriguing because the $2.4 trillion gap between deposits and loans is a familiar number. The excess reserves in the banking system is now ... also around $2.4 trillion ...

The chart below adds bank reserves held with the Fed to loans and leases - and the gap "disappears" (here we use total reserves vs. just the excess reserves, but the difference is not material to this trend.)...

 

... Coincidence? Perhaps. But if there is any validity to the explanation #4 above, it would suggest that QE, which is directly responsible for the $2.4 trillion in excess reserves, was not helpful (and possibly harmful) to credit growth in the US...."

This is not a coincidence at all. While I think the explanation of #4 is a bit off, at least it gets to the understanding that this is a consequence of reserve balance growth. I don't particularly agree that QE was harmful for credit growth, but that's going off on a tangent. Back to the loan-deposit gap:

A direct consequence of banks acting as intermediaries for QE is that they accumulate excess reserves, as well as creating deposits in the process, because the end point of QE is to swap a privately held bond for a privately held deposit. This differs from another more common form of deposit creation, whereby banks make loans by expanding their balance sheet. Under the normal loan process deposits and loans grow together:

Under QE, the Fed purchases financial assets by issuing newly created reserve balances - ex nihilo.  The balance sheet operations are fairly simple, and at the end of the asset swap the bank customer ends up with a deposit at the bank. For the bank this is a liability, and the attached asset is the reserve balance at the Fed. The bank's balance sheet looks like this:

1. The bank purchases the bond from the private sector by issuing a deposit.

2. The Fed purchases the bond from the bank by creating reserves, which it swaps for the bond.

Because there is no loan attached to the creation of these deposits, there is a buildup of excess reserves, and naturally a gap will grow between the level of outstanding loans and the level of outstanding deposits. Nothing sinister or complex, just a consequence of bank inter-mediation that should exactly match the value of excess reserves.