Posted by Joseph Y. Calhoun, III

Big banks are sitting on huge piles of cash:

Feb. 16 (Bloomberg) — U.S. lenders, criticized for being too reckless in the past and too stingy in the present, have been sitting on as much as $1.29 trillion in cash, equal to a record 98 cents for every dollar of existing business loans.

The ratio of cash to corporate loans has more than quadrupled from 21 cents in June 2008, according to Jan. 13 Federal Reserve data compiled by Bloomberg. Corporate loans shrank 14 percent to $1.32 trillion during that period as bankers tightened standards to curb record defaults and meet demands by regulators for more liquidity.

Banks are leaving more cash idle amid slack demand from borrowers throughout the economy and concern that regulators will require more liquidity to forestall another financial crisis.

The real issue for the banks is demand for loans. If banks were willing to lend to companies that are having problems right now or to entrepreneurts who lack startup funds, they’d be able to lend out as much as they want. Unfortunately, they don’t want to lend to badly managed companies; they want to lend to well run companies and those don’t want to borrow right now. And they’ve never lent to entrepeneurs with no risk capital of their own. It doesn’t work that way.

The problem is sales not a lack of credit. Responding to President Obama’s proposal to create a $30 billion small business lending program, the NFIB said:

“The number one problem facing small business is lack of sales,” said NFIB Senior Vice President Susan Eckerly. “Until consumers resume spending, small business owners will remain reluctant to start hiring. And until small businesses are confident that Washington will not increase the cost of doing business through higher taxes, healthcare mandates and increased energy costs, small business owners will continue to stay on the sidelines when it comes to hiring and expanding their businesses.”

The question is how best to get sales rising again. In the short term, as the last year has shown, monetary policy is the best policy lever to raise nominal GDP. In the longer term, we’ll need major changes in fiscal policy or any short term boost from monetary policy will just translate into inflation rather than real growth.

In the meantime, bank loans are rolling off faster than they can be replaced so bank’s returns will probably fall unless lending picks up. The only category of loan that is rising on banks balance sheets are government loans in the form of Treasuries. I suspect the banks will come to regret that decision.