Thursday, April 16, 2009

We're Turning Chinese, Not Japanese

Anyone out there know JPMorgan Chase's net interest margin, from first-quarter earnings? I've simply seen references to it as "huge" and at a decade-high. Reporting earlier this month, Wells Fargo boasted that its own margin reached a stunning 4.1 percent, which Mathew Padilla here notes is "extremely high."

This, I think, will be a big story for the banks this earnings season.

First, what is net interest margin? It sounds complicated, but it's really not. If I borrow $1,000 at 2 percent interest, then lend it at 4 percent interest, my net interest margin is 2 percent. It's also called the "spread." Clearly, the bigger the spread, the better my profits. In the above example, I make $20 for every thousand I lend. But if I expand that margin to 4 percentage points, now I'm making $40. Because banks are mainly about borrowing and lending, the size of the spread matters hugely for profits.

Banks are currently borrowing cheaply thanks to a hodgepodge of Federal Reserve programs to pump money into the economy. Ideally, to jumpstart the economy, the banks would turn around and share that cheap money at commensurately low lending rates. But the banks are wounded right now. They are desperately trying to milk profits through higher fees and lending revenue to compensate for past bad decisions that led to a backlog of toxic loans and securities. One way to do this: push on that spread and widen it out, then pocket the extra profits.

All this caused me to experience a deja vu moment. I began working as a financial journalist in China, where the state controls the banking system (and has a history of directing lending, poorly of course, and owns the largest banks in the system). To protect its banks, China has this neat regulatory trick. It imposes a lending floor (you can't offer funds below a certain rate) and a deposit ceiling (you can't pay depositors more than a certain rate). This creates a built-in spread, and it's a comfortable one, for the cosseted Chinese lenders.

So I became used to thinking of large spreads on net interest as a sign of a bloated, inefficient market, in need of a little infusion of capitalist lifeblood.

Of course the irony is now that the U.S. banks appear to be on the verge of beating out the fat spread in the Chinese banking system. China's industry had a 4.02 percent average spread in the first quarter, compared with the 4.1 at Wells Fargo (and I bet JPMorgan showed a similar number). Our banks can thank the Fed and government largesse and policy.

So there you have it. In this financial crisis, we're not turning Japanese. We're turning Chinese.