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Is Quantitative Easing (QE) a good detox for banks?
International financial markets became dysfunctional and credit dried up following the collapse of major banks and insurance companies in the US and UK in 2008. At that time, commercial banks were desperate for cash to cover their asset and liability mismatches.
In response to highly negative events, the Bank of England (BoE) launched the Quantitative Easing program, with the aim of re-establishing credit conditions by increasing inter-bank lending and, consequently, supporting the overall level of economic activity.
Did it work?
Apart from the increase in unemployment rates, the major risk posed by the deceleration of the economy was the possibility of the upsurge of the deflationary path in the aftermath of the crisis.
In order to convince the public of the bank’s decision, the ex-governor of the Bank of England, Sir Mervyn King, pointed out in an interview for ITN that the adoption of QE “would make the economy better than it would have been otherwise”.
In 2009, the Bank of England pressed on with QE announcing that it would artificially create money by increasing its liabilities to support the financial system and, more broadly, the economy. The bank bought government debt (gilts) and other assets from pension funds, commercial banks, insurance companies and non-financial firms from 2009 to 2011. The Bank of England pushed up the prices of assets by increasing demand for them. The price of assets started to increase as soon as the bank started the buyout. Through this channel the price of other financial assets increased as well. In theory, high asset prices across the market mean lower yields and lower borrowing costs for firms and households for a wide range of financial products available in the market.
As of August 2014, the Bank of England has purchased £375bn ($594bn) worth of assets from financial institutions and, consequently, increased the money holdings of the financial sector by the same magnitude.
The effectiveness of QE is difficult to measure according to Bank of England studies published a few years ago. However, it started to publish new economic and financial analysis of the effectiveness of its QE policy. According to the latest study, which looks into the impact of QE on bank’s balance sheet and banking lending, QE indeed led to an increase in lending to firms and households, albeit by a small amount. Additionally, more capitalized banks tended to lend more. However the overall impact on lending was so small in the short and in the long term, suggesting that banks mainly used the scheme to restructure their balance sheets. In numbers, in the long run, the cumulative effect of £200bn gilts buyout from the BoE corresponds to an increase in lending in the order of only 0.3%.
In line with the findings of BoE research, Marketline published a case study entitled “UK Financial System Recovery:Brutal slump and slow recovery” pointing out that in the second half of 2013 the core profit of some banks in the UK was positive for the first time since 2010 due restructuration. Additionally, it increased by 30% compared to the second half of 2012.
According to BoE research, there is a clear sign that QE worked as a good detox for banks but not necessarily for business and households, which were starved of credit lines in the aftermath of the Great Recession 2008-2009.
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