Friday, 26 March 2021

Any bank capital ratio below 100% is a subsidy of private banks.


Where bank capital ratios are on the low side, depositors’ money is at risk, thus government (aka taxpayers) have to stand behind private banks and rescue them (or maybe just rescue depositors) when things go wrong. That, ipso facto, is a subsidy of private banks and/or depositors.

Most economists concede that subsidies of commercial activities are not justified unless there is a very good justification for a subsidy, though unfortunately most economists are too indifferent to the above unjustified subsidy to bother doing anything much about it. Incidentally, depositors at a bank which also lends out money are not just simple innocent depositors: they are into commerce since the get a cut of the interest paid by borrowers.

In contrast, where capital ratios are much higher, e.g. well above the 25% or so level advocated by Anat Admati, the risk for depositors falls to a very low level, thus according to the conventional wisdom, it is not necessary to raise capital ratios any further.

Unfortunately the latter point is flawed, and for the following reasons.

Take the hypothetical scenario where bank capital ratios are 100%. That comes to the same thing as so called “100% reserves” or “full reserve banking”. In that scenario, bank loans are funded JUST BY banks, bank subsidiaries or accounts which are funded 100% by equity. Meanwhile deposits are in accounts which are 100% backed by base money at the central bank.

Now suppose a bit of stimulus is needed. There are two ways of doing that: one is to simply create and spend more base money into the economy and let people and firms devote whatever proportion of that new money they like to borrowing and lending. And the second is to artificially cut interest rates so as to bring about more stimulus by encouraging more lending.

But wait: which of those two options is nearer to a genuine free market and thus more likely to maximise GDP or output per hour? Well it’s pretty obviously not the option that involves anything ARTIFICIAL like an artificial cut in interest rates! The free market option is the one that puts more spending power into everyone’s pockets and leaves people and firms to decide for themselves how much of that new money is devoted to more lending and borrowing.
One way of cutting interest rates would be for the central bank to use the new money it has created just to lend to private banks at below the going rate of interest. Well that’s pretty obviously a subsidy of banks!

A second way of cutting interest rates would be to relax the 100% capital ratio requirement, i.e. move towards fractional reserve banking rather than full reserve. But fractional reserve is a system in which private banks can create money, and as Joseph Huber and James Robertson said in the work “Creating New Money” (p.31), the right to create / print money is  a subsidy for the money printer. If I was allowed to turn out £10 notes on my desktop printer, that would be a subsidy of little old me!

The conclusion is that it makes no difference whether bank capital ratios are above or below some sort of supposedly safe level, like the 25% advocated by Anat Admati. That is, regardless of whether they are above or below that level, any capital ratio below 100% involves a subsidy of private banks.


The conventional idea that if bank capital ratios are raised to the point where there is an absolutely minimal chance of a bank failing, that capital ratios are then high enough does not stand inspection: the reality is that ANY RATIO below 100% involves a subsidy of banks and should thus not be permitted. 


P.S. (next day, i.e. 27th Mar 2021).   Forget to say that banks are also subsidised or get preferential treatment in the following sense. One of the main activities of banks is lending. But they are nowhere near the only lenders: for example mutual funds, unit trusts and pension funds lend when they buy corporate bonds. Plus millions of firms lend when they allow customers an extended period before payment for goods is demanded. But there’s no government funded guarantee for those who put money into the latter lenders which ensures they are immune from making a loss, and there are no bailouts for those lenders.

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