Banking System

The investment portfolio of the banking has remained on the
flat side over the past year, with banks concentrating on
expanding loans and leases. The big movers have been C&I
(business) loans and the real estate book, with both advancing
13.5% yr/yr.

With indices of mortgage origination and refinance down
substantially over the past year, it is evident that banks are
growing market share in the financing of real estate. C&I
loans have reached a level relative to the banks' investment
portfolio, where it may be expected that banks may begin to
size up loan opportunities more cautiously as system liquidity
has run down rapidly since mid-2004. Liquidity depletion is
not worrisome and has proceeded in a normal cyclical fashion,
but it is time for a "heads up" nonetheless.

Banks have funded the sharply expanded credit opportunities with the
sale of jumbo deposits -- up over 20% yr/yr -- and commercial paper,
which has increased by more than 15%.

The Fed has eased up on the brake for primary monetary liquidity,
having moved from substantive tightness through most of 2005 to
a more neutral stance. So far, I would rate this a sound move,
as demand for short term business credit can run down quickly
once an economic slowdown takes hold. Failure to anticipate
such a development can result in a painful liquidity squeeze.