Thursday, March 7, 2013

BoE's Mervyn King: Lesson from history is to adopt Swedish Model for handling banks

As reported by Bloomberg, the Governor of the Bank of England, Mervyn King, laid out in his testimony before the Parliament's Commission on Banking Standards that the lesson from history on how to handle a bank solvency led financial crisis is to adopt the Swedish Model.
He contrasted Japan’s failure to restructure its banking system with Sweden’s nationalization, overhaul and rapid return of its lenders to private ownership in the 1990s. 
RBS has crimped lending and growth in the U.K. since its bailout, King said. 
“The lessons of history show very clearly that it is not a good idea to have banks in the public sector for very long,” King said. “The financial markets realized that the losses out there don’t go away. It’s better to face up to it.”...
“The arguments for a restructuring sooner rather than later are powerful ones,” King said. “I’d be willing to lend my support. We shouldn’t worry about the consequential impact.”
Please re-read the highlighted text again as Sir Mervyn King has just championed your humble blogger's call for adoption of the Swedish Model for handling a bank solvency led financial crisis.

It is unnecessary given the design of a modern banking system to take a bank into public ownership (which is what any form of bailout is) to restructured them and recapitalize them quickly.

By design, banks can operate and continue to support the real economy when they have low or even negative book capital levels.

Banks can do this because of the combination of deposit insurance and access to central bank funding.  Deposit insurance effectively makes the taxpayers the bank's silent equity partner when they have low or negative book capital levels.  This is what lets banks continue to operate and support the real economy.

What would force banks to restructure quickly is if banks were required to provide ultra transparency and disclose their current global asset, liability and off-balance sheet exposure details.  This level of disclosure is needed so that banks are subject to market discipline.

With this information, market participants can assess the risk the banks are taking and link the amount and price of their exposure to each bank to the risk it is taking.  It is this linkage between cost of funds and risk that is the driver of market discipline.

And why would market participants link the cost of funds to the risk each bank is taking?

Market participants know they are responsible for all losses on their investments as a result of having access to all the useful, relevant information in an appropriate, timely manner to independently assess and make a fully informed investment decision.

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