Tuesday, May 15, 2012

Make banking boring

In his NY Times column, Joe Nocera calls for making banking boring again by ending the large banks' addiction to trading profits.

To do this, he offers the following formula.

“I just want all this garbage out of insured banks,” said Sheila Bair, the former head of the Federal Deposit Insurance Corporation. “A bank with insured deposits should be making loans. If they have excess they should put the money in safe government securities. If they want to trade, set up separate subsidiaries that have higher capital requirements.”
I must be too old, but I don't recall this formula makes banks boring.

Back in my youth, the largest banks in the US showed they were perfectly capable of blowing themselves up from taking on credit risk by making loans to Less Developed Countries (believing that people go bankrupt, but countries never do will do that to a bank).

Slightly later, the savings and loan industry showed it was capable of blowing itself up as a result of interest rate risk (borrowing short and lending long in a rising rate environment will do that to a bank).

In our current global financial crisis, the EU banks have demonstrated the risk of investing in government securities (oops, governments really do go bankrupt).  The definition of a safe government security needs to be very precise as shown by the fact that the bailout of Fannie Mae and Freddie Mac covered their RMBS guarantees but not their preferred stock.

I prefer a different formula for making banks boring.  Require banks to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.

With this information, market participants can assess the risk of each bank and exert discipline.  Market discipline that adjusts a bank's cost of and access to funds to reflect the risk the bank is taking.

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