What a delight to see one’s predictions about feckless bank regulators come true within a week making them. Briefly, I said last week that banks would knobble regulators. And the main front page story of yesterday’s Financial Times (7th Jan) was headed “Massive softening of Basel bank rules”. Of course I’m far from the only person to make that prediction!!!
More details as follows.
In relation to banks, an important question is what proportion of their creditors should be loss absorbers. For example the standard view is that it’s only shareholders and bondholders who should stand to be wiped out come a bank failure. And that’s roughly 10-20% of creditors - the rest being depositors or other types of “we refuse to take a haircut” creditor.
The alternative (which I back) is that 100% of creditors should be loss absorbers, and that is what is involved in full reserve banking. To be more accurate, loans and investments made by banks (or other lending / investing entities) should be 100% covered by loss absorbers. In contrast, there is money that depositors do not want to be loaned on because they want it to be 100% safe, but under full reserve, that money is not loaned on or invested, so it’s 100% safe, ergo no loss absorbers are needed.
So which is best: 10-20% or 100%? Well one argument for the latter is that as I put it here, “It is easy for banks to gradually lobby a 10-20% figure down to impotence (if they haven’t done so already). In contrast, 100% is a clear line in the sand.” Vindicated or what?
And in relation to the complexity of Basel or Frank-Dodd type legislation I said here that, “Because of the complexity, it is easy for banks to water down the legislation via lobbying.” And “In contrast, the basic rules of full reserve are just two in number and are simple.” Thus full reserve is relatively lobby-proof.