Why banking remains far too undercapitalised for comfort
Leverage ratios closer to 5:1 will help give creditors confidence in liabilities
by Martin Wolf
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Banking sector stability still faces issues 10 years on from the run on Northern Rock © Getty
Just over 10 years ago, the UK experienced, with Northern Rock, its first visible bank run in one-and-a-half centuries. That turned out to be a small event in a huge crisis. The simplest question this anniversary raises is whether we now have a safe financial system. Alas, the answer is no. Banking remains less safe than it could reasonably be. That is a deliberate decision.
Banks create money as a byproduct of their lending activities. The latter are inherently risky.
That is the purpose of lending. But banks’ liabilities are mostly money. The most important purpose of money is to serve as a safe source of purchasing power in an uncertain world.
Unimpeachable liquidity is money’s point. Yet bank money is least reliable when finance becomes most fragile. Banks cannot deliver what the public wants from money when the public most wants them to do so.
This system is designed to fail. To deal with this difficulty, a source of so much instability over the centuries, governments have provided ever-increasing quantities of insurance and offsetting regulation. The insurance encourages banks to take ever-larger risks. Regulators find it very hard to keep up, since bankers outweigh them in motivation, resources and influence.
A number of serious people have proposed radical reforms. Economists from the Chicago School recommended the elimination of fractional reserve banking in the 1930s. Mervyn King, former governor of the Bank of England, has argued that central banks should become “pawnbrokers for all seasons”: thus, banks’ liquid liabilities could not exceed the specified collateral value of their assets. One thought-provoking book, The End of Banking by Jonathan McMillan, recommends the comprehensive disintermediation of finance.
All these proposals try to separate the risk-taking from the public’s holdings of unimpeachably safe liquid assets. Combining these two functions in one class of institutions is a recipe for disaster, because the first function compromises the second, and so demands huge and complex interventions by the state. That is simply not a market solution.
Radical reforms are desirable. But today this is politically impossible. We have to build, instead, on the reforms introduced since the crisis. I was involved in the recommendations from the UK’s Independent Commission on Banking for higher loss-absorbing capacity and the ringfencing of UK retail banks. Both are steps in the right direction. Even so, as Sir John Vickers, chairman of the ICB, noted in a recent speech, the reforms have not yet made the banks’ role as risk-taking intermediaries consistent with their role as providers of safe liabilities. That is largely because they remain highly undercapitalised, relative to the risks they bear.
Senior officials argue that capital requirements have increased 10-fold. Yet this is true only if one relies on the alchemy of risk-weighting. In the UK, actual leverage has merely halved, to around 25 to one. In brief, it has gone from the insane to the merely ridiculous.
The smaller the equity funding of a bank, the less it can afford to lose before it becomes insolvent. A bank near insolvency must not be allowed to operate, since shareholders have nothing left to lose from taking huge bets. There is, however, a simple way of increasing the confidence of a bank’s creditors in the value of its liabilities (without relying on government support). It is to reduce its leverage from 25 to one to, say, five to one, as argued by Anat Admati and Martin Hellwig in The Bankers’ New Clothes.
As Sir John notes, this would impose private costs on bankers, which is why they hate the idea.
But it would not impose significant costs on society at large. Yes, there would be a modest increase in the cost of bank credit, but bank credit has arguably been too cheap. Yes, the growth of bank-created money might slow, but there exist excellent alternative ways of creating money, especially via the balance sheets of central banks. Yes, shareholders would not like it.
But banking is far too dangerous to be left to them alone. And yes, one can invent debt liabilities intended to convert into equity in crises. But these are likely to prove difficult to operate in a crisis and are, in any case, an unnecessary substitute for equity.
The conclusion is simple. Banks are in better shape, on many fronts, than they were a decade ago (though the questionable treatment of income and assets in banks’ accounts continues to render their financial robustness highly uncertain). But their balance sheets are still not built to survive a big storm. That was true in 2007. It is still true now. Do not believe otherwise.
domingo, octubre 15, 2017
WHY BANKING REMAINS FAR TOO UNDERCAPITALIZED FOR COMFORT/ THE FINANCIAL TIMES COMMENT & ANALYSIS
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Etiquetas:
Banks And Banking
Russia’s Foreign Policy of Disruption
By Jacob L. Shapiro
domingo, octubre 15, 2017
AMERICANS ARE RICHER; WHY ARE THEY STILL CAUTIOUS? / THE WALL STREET JOURNAL
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Etiquetas:
Consumers,
Household Wealth,
U.S. Economic And Political
Americans Are Richer; Why Are They Still Cautious?
Household wealth hit a new high, but that hasn’t made Americans more willing to spend
By Justin Lahart
Getting richer doesn’t make people spend like it used to. That should give the Federal Reserve less to worry about when it comes to consumers, but more to worry about when it comes to asset prices.
Lifted by rising home prices and a buoyant stock market, U.S. household net worth reached a record $96.2 trillion in the second quarter, the Fed reported Thursday, up $1.7 trillion from the first quarter. That compared with $68.2 trillion a decade earlier, just before the recession hit.
The wealth-to-income ratio hit a new high of 670%.
But if households are feeling flush they aren’t acting like it. Consumer spending has been tepid, and people have been far less willing to tap wealth to fuel spending than they used to be. Bank of America Merrill Lynch estimates that for each dollar gain in housing wealth, people increase their spending by just two cents, versus five cents in the mid-1990s. For stock gains, the figure has slipped to one cent from four cents.
RICH FEELING
Net worth as a share of disposable income (1960-2017)
There are few likely reasons for the change in behavior. First, people don’t put as much trust in the staying power of wealth gains. The big stock market drops following the dot-com bust and the financial crisis are hard to forget, and the housing bubble ended the old notion that home values are safe. Second, a greater share of U.S. stock market and housing wealth is concentrated in the hands of the rich, who don’t boost their spending in response to wealth gains as much as other people do. Finally, tighter lending standards have made it more difficult to tap into housing wealth than it was before the financial crisis.
During the early years of the recovery, as asset prices rebounded but the economy only trudged along, the Fed probably wished Americans weren’t so hesitant to spend their wealth. But now, with the economy healthier and the Fed tightening, the central bank is probably pleased that it does not have to rein in reckless consumer spending, points out Merrill economist Michelle Meyer.
The downside is that is that if consumer behavior and asset prices continue to diverge, the Fed could face some difficult choices. Say that consumer spending remains muted, the economy grows at the same steady pace and inflation remains low as a result. And say that stock prices keep on rising, stretching valuations to the point where they look frothy. Under those circumstances, should the Fed keep rates steady, and risk a bubble? Or raise rates to cool asset prices, and risk pushing consumer spending and inflation dangerously lower?
domingo, octubre 15, 2017
MAKING THE SANCTIONS ON NORTH KOREA WORK / PROJECT SYNDICATE
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Etiquetas:
China,
North Korea,
Nuclear Security,
U.S. Economic And Political
Making Economic Sanctions on North Korea Work
Yasheng Huang
CAMBRIDGE – Last week, in a brazen rebuff to tough new United Nations sanctions, North Korean leader Kim Jong-un’s regime fired a ballistic missile over the northern Japanese island of Hokkaido – its second launch over Japan in less than three weeks. But, far from indicating that sanctions don’t work, Kim’s move shows that they still aren’t tough enough.
The latest sanctions cap oil imports, ban textile exports, and penalize designated North Korean government entities. Following Kim’s response, sanctions should be tightened even further, to stop all trade with North Korea, including halting all fuel imports.
North Korea is one of the most insular countries in the world. That insularity is a curse for the long-suffering North Korean people, but an advantage for a sanction-based strategy, because only one country is needed to make it work: China.
From an economic perspective, China is the only country that really matters to North Korea, as it controls about 90% of the North’s foreign trade and supplies almost all of its fuel. Yet China’s economy would barely register the effect of new sanctions: North Korea’s annual GDP, at a meager $28 billion, constitutes little more than a rounding error for its giant neighbor.
The lack of viable commercial alternatives and the massive asymmetry of power between North Korea and those imposing sanctions mean that a stricter sanctions regime would push the country into a corner. The question is whether economic hardship would induce North Korea to change its nuclear policy. Though it is impossible to say for sure, a look at the economics of North Korea’s nuclear program suggests that it might.
Contrary to popular perception, nuclear arms are weapons of the poor – extraordinarily cheap compared with conventional armaments. In fact, it was this rationale that drove the Soviet Union’s massive nuclear buildup: Soviet leaders, recognizing that they could not compete with the much wealthier United States’ conventional weapons, focused their country’s limited resources on creating a potentially devastating nuclear arsenal.
Likewise, North Korea’s focus on nuclear, rather than conventional, weapons may be enabling it to minimize the tradeoff between guns and butter. Indeed, there are reports of some vitality in the North Korean economy, with markets full of goods and new buildings under construction. Tighter sanctions are therefore needed to increase the economic price that the regime must pay for its nuclear program.
Even if North Korea does not change its policy, total economic isolation may bring about an end to its nuclear program, by sowing internal discord and, ultimately, triggering the regime’s collapse. Yet China hopes to avoid precisely this outcome – which is a key reason why it has so far refused to escalate sanctions further.
China worries that the collapse of the Kim regime would fuel a major refugee crisis, with millions of Koreans pouring across its border in search of food, shelter, and security – and imposing heavy economic and social costs on China in the process. Moreover, Chinese leaders fear the loss of the North Korean buffer separating China from US troops stationed in South Korea. Given the widespread belief in Chinese policy circles that the US secretly hopes to re-fight the Korean war and establish a single US-allied Korea on China’s border, the potency of this concern should not be underestimated.
US President Donald Trump’s administration understands the central importance of China to any strategy to rein in North Korea’s nuclear ambitions. But, so far, the US has relied on threats, such as halting $650 billion in bilateral trade, to persuade China to cooperate. This is not a stick, but a boomerang – one that will hit China and immediately return to smack the US.
What is needed instead are carrots. Persuading China to isolate the North economically will require the international community to establish some agreement regarding how regime collapse would be handled, with an eye to allaying China’s key concerns.
For starters, the entire international community, but especially the US, must explicitly pledge not to attempt to change the nature of the North Korean regime. That means that if the Kim regime collapses, the US will not pursue reunification. Instead, China should exercise primary political custodianship of North Korea in the event that a political vacuum emerges. Come what may, US and South Korean troops would not cross the 38th parallel.
Persuading China to impose potentially regime-destroying sanctions will also require economic pledges, with the entire international community – especially the US, Japan, and South Korea – committing to share the mammoth costs of sheltering refugees and rebuilding North Korea’s economy. While China would inevitably cover a substantial share of these costs, owing to its geographic proximity and historic ties to the North, it needs reassurance that it would not be left to shoulder the burden alone.
Admittedly, this approach is somewhat reminiscent of the one taken at the 1945 Yalta Conference, where leaders of the Soviet Union, the United Kingdom, and the US carved out geopolitical spheres of influence in post-World War II Europe. Moral and ideological objections, therefore, are to be expected.
But it’s time to get real. The nuclear threat posed by North Korea is serious, immediate, and requires a bold response. This is not the time to be constrained by conventions and ideology; it is the time to do whatever is needed to defuse nuclear tensions and protect the lives of those in the Kim regime’s crosshairs.
China is the only country with the power to force North Korea to change its nuclear policy.
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Estimados amigos,
Les doy cordialmente la bienvenida a este Blog informativo con artículos, análisis y comentarios de publicaciones especializadas y especialmente seleccionadas, principalmente sobre temas económicos, financieros y políticos de actualidad, que esperamos y deseamos, sean de su máximo interés, utilidad y conveniencia.
Pensamos que solo comprendiendo cabalmente el presente, es que podemos proyectarnos acertadamente hacia el futuro.
Gonzalo Raffo de Lavalle
Les doy cordialmente la bienvenida a este Blog informativo con artículos, análisis y comentarios de publicaciones especializadas y especialmente seleccionadas, principalmente sobre temas económicos, financieros y políticos de actualidad, que esperamos y deseamos, sean de su máximo interés, utilidad y conveniencia.
Pensamos que solo comprendiendo cabalmente el presente, es que podemos proyectarnos acertadamente hacia el futuro.
Gonzalo Raffo de Lavalle
Las convicciones son mas peligrosos enemigos de la verdad que las mentiras.
Friedrich Nietzsche
Quien conoce su ignorancia revela la mas profunda sabiduría. Quien ignora su ignorancia vive en la mas profunda ilusión.
Lao Tse
“There are decades when nothing happens and there are weeks when decades happen.”
Vladimir Ilyich Lenin
You only find out who is swimming naked when the tide goes out.
Warren Buffett
No soy alguien que sabe, sino alguien que busca.
FOZ
Only Gold is money. Everything else is debt.
J.P. Morgan
Las grandes almas tienen voluntades; las débiles tan solo deseos.
Proverbio Chino
Quien no lo ha dado todo no ha dado nada.
Helenio Herrera
History repeats itself, first as tragedy, second as farce.
Karl Marx
If you know the other and know yourself, you need not fear the result of a hundred battles.
Sun Tzu
Friedrich Nietzsche
Quien conoce su ignorancia revela la mas profunda sabiduría. Quien ignora su ignorancia vive en la mas profunda ilusión.
Lao Tse
“There are decades when nothing happens and there are weeks when decades happen.”
Vladimir Ilyich Lenin
You only find out who is swimming naked when the tide goes out.
Warren Buffett
No soy alguien que sabe, sino alguien que busca.
FOZ
Only Gold is money. Everything else is debt.
J.P. Morgan
Las grandes almas tienen voluntades; las débiles tan solo deseos.
Proverbio Chino
Quien no lo ha dado todo no ha dado nada.
Helenio Herrera
History repeats itself, first as tragedy, second as farce.
Karl Marx
If you know the other and know yourself, you need not fear the result of a hundred battles.
Sun Tzu
We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.
Paulo Coelho
Paulo Coelho

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