Saturday, 9 June 2012

The root cause of Spanish banking problems.

The root cause of Spanish banking problems, and indeed pretty wall all banking problems, is as follows.

When anyone deposits X money units at a bank ($,£,etc) the bank undertakes to return the same number of units (possibly plus some interest and possibly minus administration expenses).

But banks also lend the money on to a variety of borrowers who are certainly NOT GUARANTEED to return the money: they may go bust.

Thus the central promise made by banks is a complete nonsense: it’s a confidence trick. (Yes I know I’ve made this point before: I’ll carry on banging on about it till I get the point across.).

Unfortunately, the above confidence trick is one that banks have fooled governments into underwriting: politicians are easily fooled.

Does adequate capital solve the problem?

It might seem that the above risk run by banks can be dealt with by ensuring that banks have adequate capital. But just look that the shambolic history of the “adequate capital” idea. A few months prior to the collapse of Northern Rock (according to Mervyn King), the best capitalised bank in Britain was . . . . . Northern Rock. So the "experts" who set up the rules that determined and defined capital adequacy for banks prior the collapse of Northern Rock were obviously clueless.

So have British and European authorities learned anything since the collapse of Northern Rock? Nope. They learned nothing.

In 2011, the European Banking Association, plus the European Central Bank and the European Systemic Risk Board supervised stress tests on all major European banks, and what do you know? Bankia, the shambolic Spanish bank passed with flying colours.

Bankia now needs 20 billion Euros and counting if it’s to avoid going belly up. The whole capital adequacy idea is a farce. It is a nonsense.

It’s OK in theory, but the REALITY is that banks talk politicians into buying bum steers. So what we need is an ultra simple set of rules that the fraudsters and crooks who run banks cannot talk their way out of.

Here is a simple rule.

The solution is for us to call an end to the above confidence trick which is at the heart of banking.

Where anyone deposits money in a bank which in turn lends the money on to any sort of private sector or commercial entity, the bank should be forbidden to make promises about the depositor being guaranteed to get their money back.

Indeed, all communications from the bank to the depositor should contain a health warning to the effect that “you are NOT GUARANTEED to get your money back”.

Such a depositor is effectively into commerce. What they are doing is no different to investing on the stock exchange.

Everyone has right to a 100% safe account. But the only circumstance in which the state should give a guarantee that money will be returned is where the state itself looks after the money: i.e. where the money is deposited at the central bank.

That does not mean that central banks need to open accounts for everyone wanting a 100% safe account: private banks could perfectly well act as agents for central banks: i.e. collect money from those wanting 100% safe accounts and deposit the money at the central banks.

Re the above “you are not guaranteed to get your money back” stipulation, there are numerous ways of working this, and individual banks can probably be left to sort this out themselves. For example, one option would be to let the value of each currency unit deposited at a bank FLOAT in the same way as the market price of a unit trust or mutual fund units float up and down. To illustrate, the value of every thousand Euros deposited at Bankia a few years ago would by now be near worthless.

The latter proposal is very similar to the “limited purpose banking” idea put by Laurence Kotlikoff in his book “Jimmy Stewart is Dead”. Incidentally, Kotlikoff is said to be Mervyn King’s “guru”.

Beware of bankster lies.

Private banks will of course object to the above proposal, and on the wholly specious grounds that restricting bank lending will curb economic growth.

That argument is TOTAL AND COMPLETE BULLSHIT, and for the following reason.

Removing the above state guarantee for bank deposits, that is the “too big to fail subsidy” (not to mention the occasional 20 billion Euro bailout) will of course reduce lending. But the optimum amount of lending, just like the optimum amount of any commodity, will not be attained if the commodity is subsidised! I.e. the optimum amount of bank lending is almost certainly a lot less than currently takes place.

Of course removing the TBTF subsidy will have a deflatinary effect. But that effect is easily countered by a dose of stimulus.

The net result would be less bank lending based economic activity relative to other forms of activity, e.g. equity funded activity, or activity that does not require so much capital investment.

A further point that supports the idea that we need less bank lending is thus. Bank assets relative to GDP have expanded a whapping TENFOLD relative to GDP over the last 30 years, and to what benefit? Anyone know? Growth is no better than 30 years ago: indeed over the last 5 years, growth has been HOPELESS compared to 30 years ago. (See p.3 of this Bank of England publication regarding the above expansion of UK banks over the last 30 years.)

Incidentally, I’m nowhere near the first person to suggest that banks’ objections to tighter regulation are a pack of lies. This Financial Times front page report made the same point.


Hat tip to Frances Coppola for the above link relating to the European Central Bank, and other Euro organisations.



  1. Perhaps you'd consider emailing your MP, as I have just done?

  2. I'm not ultra enthusiastic about protecting savers from the ravages of inflation (though I have no big objections to the National Savings inflation proofed accounts). This is too comlex an issue to deal with in a comment after a blog post, so I'll do a special post on this subject in a day or two.

  3. The stock market is thoroughly corrupt, and now you say you are not in favour of protecting cash against inflation. Physical assets, especially those purchased with the assistance of debt, are overpriced.

    If sound money is not to be, then it seems to me that unless one is part of the elite battening on the financial system, sucking out wealth faster than it is diminished by inflation, impoverishment is certain.

  4. Dear Ralph,

    most of bank deposits are cash for rainy day rather than an attempt to accumulate as much interest as possible. Without government protection scheme it would be much safer to stash the cash under the bed or spend it on buying stuff. Abandoning GPS could be quite interesting approach for stimulating aggregate demand.

    1. Yes, the initial effect of abandonning government proctection would be a rise in aggregate demand. I.e. where governemnt offers protection for hoarded cash, people will will hoard more cash than they otherwise would. I hadn't thought of that effect.


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