Tuesday, 1 September 2015
Either banks are subsidised, or they have 100% capital ratios.
If government so much as hints it will rescue banks in trouble, that’s a subsidy of banks. And subsidies misallocate resources, i.e. reduce GDP. Alternatively, if government completely washes its hands off banks, then all of those who fund banks become shareholders, even if they’re called depositors or bondholders. That’s shareholder as in “someone who at worst stands to lose everything”. Cyprus anyone? And that system equals full reserve banking.
A plausible escape from that check mate position for conventional banking might seem to be to retain depositors in the conventional sense, and cover the risk with FDIC type insurance and multi trillion dollar loans from central banks for larger banks (which of course will be at Bagehot’s penalty rates rather than sweetheart rates – ha ha).
Unfortunately that escape is blocked. Leave aside the probability that loans will be at sweetheart rates rather than Bagehot’s penalty rates, insurance involves moral hazard, i.e. the temptation to take excess risk, keep the profit when that works, and send the bill to the insurer when it doesn’t. And that’s a very real cost. To a significant extent that phenomenon was behind the credit crunch. And the credit crunch involved ASTRONOMIC costs in terms of lost GDP. Ergo “self insurance”, which is what shareholders do, is cheaper than FDIC type insurance.
So… conventional banking is in check mate. To put it more bluntly, conventional banking is B.S.