Friday, 1 December 2017

Higher bank capital ratios raise bank lending???

David Miles (economics prof at Imperial College, London) makes the odd claim in the Financial Times that raising bank capital ratios can result in banks lending MORE.

A large majority of those who have examined this question either think that raising capital ratios has no effect on bank lending or that the effect is to CUT lending. Those who back the “no effect” claim normally cite the Modigliani Miller theory, while those who claim that bank lending is cut normally claim that the MM theory is defective. Far as I can see, criticisms of MM are pretty feeble. I run thru them under the heading “Flawed criticisms of Modigliani Miller” here. So I conclude on that basis that raising bank capital ratios has no effect on bank lending.

However, the higher bank capital ratios are, the more difficult it is for commercial banks to create / print money. And as Milton Friedman among others explained, when the ratio is 100% (favoured by Friedman and others), then commercial banks, as Friedman explained, cannot create money at all. Plus the “right to print” pretty obviously amounts to a subsidy of commercial banks (as explained by Joseph Huber (p.31)). And cutting a subsidy for an industry contracts that industry. Thus I would claim that raising capital ratios  will in fact cut lending.

However, given the enormous expansion of lending and debt in recent years, that is hardly a big problem. Plus the deflationary effect of less lending is very easily countered via conventional stimulus, fiscal and/or monetary.

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