The Emperors Of Banking Have No Clothes-Books Pdf

The Emperors of Banking Have No Clothes
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Copyright Princeton University Press No part of this book may be. distributed posted or reproduced in any form by digital or mechanical. means without prior written permission of the publisher. 2 CHAPTER ONE, stupid or unfit for their jobs The emperor orders a full set of these special. clothes When he sends his ministers to monitor the tailors the ministers. do not see anything but for fear of being considered stupid or incompetent. none of them admits this Instead they extol the splendors of the invisible. clothes and the nonexistent fabrics of which they are made. The emperor himself finds his new attire invisible yet not wanting to. appear stupid or unfit to be emperor he praises the nonexistent clothes When. he tours his capital wearing them the onlookers also admire his attire. even though they do not see anything Only when a little child shouts The. emperor has no clothes does everyone realize and admit that the emperor. is in fact naked, A major reason for the success of bank lobbying is that banking has a cer. tain mystique There is a pervasive myth that banks and banking are special. and different from all other companies and industries in the economy Any. one who questions the mystique and the claims that are made is at risk of. being declared incompetent to participate in the discussion 6. Many of the claims made by leading bankers and banking experts actu. ally have as much substance as the emperor s new clothes in Andersen s. story But most people do not challenge these claims and the claims have. an impact on policy The specialists fa ade of competence and confidence. is too intimidating Even people who know better fail to speak up The em. peror may be naked but he continues his parade without being challenged. about his attire 7, Our purpose in writing this book is to demystify banking and explain the. issues to widen the circle of participants in the debate We want to encourage. more people to form and to trust their opinions to ask questions to express. doubts and to challenge the flawed arguments that pervade the policy debate. If we are to have a healthier financial system more people must understand. the issues and influence policy, Many have a sense that something is wrong with banking and have ques. tions Why did banks get into so much trouble in the crisis Why were banks. and other financial institutions bailed out Were the bailouts necessary Will. these institutions be bailed out again if they run into trouble Will new regu. lations help or hurt Are they too tough or not tough enough. For general queries contact webmaster press princeton edu. Copyright Princeton University Press No part of this book may be. distributed posted or reproduced in any form by digital or mechanical. means without prior written permission of the publisher. THE EMPERORS OF BANKING HAVE NO CLOTHES 3, Leading bankers have simple answers to these questions They may admit.
that mistakes were made 8 but they portray the crisis primarily as a fluke an. accident that is highly unlikely to recur in our lifetimes 9 It would be costly. and wasteful they claim to tighten regulation to forestall an event that might. happen once in a hundred years Tighter regulation we are warned would. interfere with what banks do to support the economy and this would have. serious unintended consequences 10, The English classical scholar Francis Cornford wrote in 1908 There is. only one argument for doing something the rest are arguments for doing. nothing The argument for doing something is that it is the right thing to do. Then of course comes the difficulty of making sure that it is right 11 He goes. on to explain how bugbears sources of dread or false alarms are used to. raise doubts or scare If Cornford was writing today he would surely talk. about the bugbear of unintended consequences, Meanwhile politicians seem to be taken in by the lobbying For all the. outrage they expressed about the crisis they have done little to actually. address the issues involved For example one might infer from President. Sarkozy s lashing out at bankers that France is a champion of bank regula. tion But this inference would be wrong In the bodies that try to coordinate. regulatory efforts across countries France has consistently opposed any. tightening of regulation 12 In the United States regulations are often watered. down in response to bank lobbying For example in passing the Dodd Frank. Act in 2010 Congress weakened the so called Volcker Rule which prohibits. commercial banks from trading securities on their own account Lobbying. also affects the so called rule making process by which the regulatory bodies. implement the law 13, Much of the research on banking the financial crisis and regulatory. reform takes for granted that banks and the financial system must be as vul. nerable to risks as they are so that the failure of one bank can pull down the. entire financial system Some academic research suggests that this fragility. might actually be a necessary by product of the benefits banks provide to the. economy 14 However this work is based on assumptions under which fragil. ity is indeed unavoidable without assessing the relevance of the assumptions. in the real world 15, For general queries contact webmaster press princeton edu. Copyright Princeton University Press No part of this book may be. distributed posted or reproduced in any form by digital or mechanical. means without prior written permission of the publisher. 4 CHAPTER ONE, Expanding the policy discussion beyond the circle of bankers and bank.
ing specialists is very important because more action is urgently needed. and yet has not been taken 16 The banking system is still much too fragile. and dangerous This system works for many bankers but it exposes most of. us to unnecessary and costly risks and it distorts the economy in signifi. Can something be done at a reasonable cost to reduce the likelihood of. banks failing and causing a costly crisis In one word Yes Will the reforms. that have been decided upon achieve this aim No Can we have regulations. that greatly increase the health and safety of the system while still allowing. banks to do everything the economy needs them to do Yes Would we as. a society have to sacrifice anything substantial to have a better banking. One clear direction for reform is to insist that banks and other financial. institutions rely much less on borrowing to fund their investments The re. forms that have been agreed upon since 2008 are woefully insufficient in this. respect and they maintain previous approaches that have not worked well. The benefits of a more ambitious reform would be significant whereas con. trary to the claims of leading bankers and others the relevant costs to society. would be quite small if they existed at all, We are not saying that stricter limits to bank borrowing are the only mea. sures to be considered However these measures are important and benefi. cial no matter what else might be done Reducing the excessive risks to the. economy from the banking system particularly the large distortions that. result from having institutions that are too big to fail may well require. additional measures The key is to try to provide better incentives for market. participants and for those who design and implement regulations so that. bankers actions will be less in conflict with the public interest. A Sampling of the Bankers New Clothes, A few examples will illustrate what we mean by the bankers new clothes. Excessive borrowing by banks was identified as a major factor in the crisis of. 2007 2008 Bankers themselves sometimes admit this 17 Nevertheless the. banking industry fights aggressively against tighter restrictions on bank bor. For general queries contact webmaster press princeton edu. Copyright Princeton University Press No part of this book may be. distributed posted or reproduced in any form by digital or mechanical. means without prior written permission of the publisher. THE EMPERORS OF BANKING HAVE NO CLOTHES 5, rowing The constant refrain is that too much tightening of such restrictions. would harm economic growth, For example in 2009 when negotiations about a new international agree. ment on banking regulation were getting under way Josef Ackermann then. the CEO of Deutsche Bank asserted in an interview that tighter restrictions. on bank borrowing would restrict banks ability to provide loans to the. rest of the economy This reduces growth and has negative effects for all 18. This is a typical bugbear suggesting that we must make a choice between. economic growth and financial stability and that we cannot have both After. all who would be in favor of a regulation that reduces growth and has nega. tive effects for all, Mr Ackermann acknowledged that tighter restrictions on banks borrow.
ing might increase bank safety but he insisted that this would come at the. expense of growth He said nothing however about how continued financial. instability and turmoil would affect growth, The sharpest economic downturn since the Great Depression of the early. 1930s occurred in the last quarter of 2008 and it was a direct result of the. worldwide financial crisis that affected numerous banks and other financial. institutions The unprecedented decline in output in 2009 and the resulting. loss of output have been valued in the trillions of dollars 19 The crisis has. caused significant suffering for many 20 In light of these effects warnings that. greater financial stability would come at the expense of growth sound hollow. Warnings that bank lending would suffer also sound hollow In 2008 and. 2009 banks that were vulnerable because they had too much debt cut back. sharply on their lending The severe credit crunch was caused by banks hav. ing too much debt hanging over them, Why would restrictions on bank borrowing have any effect on bank lend. ing at all, One argument was given in 2010 by the British Bankers Association which. claimed that new regulations would require U K banks to hold an extra. 600 billion of capital that might otherwise have been deployed as loans to. businesses or households 21 To anyone who does not know what the regula. tion is about this argument may look plausible In fact it is nonsensical and. For general queries contact webmaster press princeton edu. Copyright Princeton University Press No part of this book may be. distributed posted or reproduced in any form by digital or mechanical. means without prior written permission of the publisher. 6 CHAPTER ONE, The nonsense is due to the misuse of the word capital In the language of. banking regulation this word refers to the money the bank has received from. its shareholders or owners This is to be distinguished from the money it has. borrowed Banks use both borrowed and unborrowed money to make their. loans and other investments Unborrowed money is the money that a bank. has obtained from its owners if it is a private bank or from its shareholders if. it is a corporation along with any profits it has retained Elsewhere in the. economy this type of funding is referred to as equity In banking it is called. Capital regulation requires that a sufficient fraction of a bank s invest. ments or assets be funded with unborrowed money 22 This is similar to the. requirement that a home buyer make a minimum down payment when buy. ing a house Having a minimal ratio of unborrowed funds relative to total. assets is a way to limit the share of assets that is funded by borrowing Because. unborrowed funds are obtained without any promise to make specific pay. ments at particular times having more equity enhances the bank s ability to. absorb losses on its assets, From the statement of the British Bankers Association however we would.
not guess that capital requirements are about how much a bank borrows The. statement makes it appear as if capital were a cash reserve a pile of cash that. banks hold that cannot be used to make loans, In fact capital regulation does not tell banks what to do with their funds. or what they should hold It tells banks only what portion of the funds they. use must be unborrowed Saying that new regulations would require U K. banks to hold an extra 600 billion of capital is nonsensical The implica. tion that loans to businesses or households are automatically reduced by that. 600 billion is false Capital is not a rainy day fund. The confusion about the term bank capital is pervasive Numerous media. reports say that banks must set aside capital to satisfy new regulations. References to capital reserves suggest that the regulation forces banks to hold. cash that sits idly in the bank s tills without being put to work in the econ. omy 23 A bank lobbyist is quoted as saying A dollar in capital is one less dol. lar working in the economy 24, For general queries contact webmaster press princeton edu. Copyright Princeton University Press No part of this book may be. distributed posted or reproduced in any form by digital or mechanical. means without prior written permission of the publisher. THE EMPERORS OF BANKING HAVE NO CLOTHES 7, This confusion is insidious because it biases the debate suggesting costs. and trade offs that do not actually exist The trade offs exist for reserve. requirements which call for banks to hold some fraction of their deposits in. cash or in deposits with the central bank However capital. THE EMPERORS OF BANKING HAVE NO CLOTHES 3 Leading bankers have simple answers to these questions Th ey may admit that mistakes were made 8 but they portray the crisis primarily as a fl uke an accident that is highly unlikely to recur in our lifetimes 9 It would be costly and wasteful they claim to tighten regulation to forestall an event that might

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