Search interesting materials

Sunday, April 26, 2009

Deep thinking on banking

Forbes has a fascinating article by Laurence J. Kotlikoff and Edward Leamer, with fundamental thinking about banks.

They trace the problems of banks to the fundamental contradictions of having a highly leveraged financial firm, with assured returns and full liquidity for depositors, and opaque + illiquid assets. I agree with this gloomy prognosis. A more fleshed out argument is in this pair of articles -- link and link -- which were opinion pieces in 1999.

I stopped chasing those lines of thought because it seemed dishearteningly hard, trying to sell a world without banks as we know 'em. But if you are persuaded by these arguments, then you will like a world where we do more finance through securities markets, through `defined contribution and NAV-based' financial firms (i.e. direct household participation in financial markets, mutual funds and DC pensions), and less through `assured returns' financial firms such as banks, DB pensions and insurance companies.

In a perverse way, India's prodigous mistakes of policy on banking have helped steer the country into a more market-dominated financial system, which has helped build a better financial system.

Since we're unlikely to reconstruct the economy in radical ways, we have to confront the problems of banks. I feel the most important element of safe and sound banking is: a proper deposit insurance mechanism. Chapter 6 of Raghuram Rajan's report is the best blueprint out there about setting up a deposit insurance corporation, and other dimensions of improving systemic risk (see `V. Preventing Crisis and Dealing with Failure').

You might like to also see this picture on banking reforms.

No comments:

Post a comment

Please note: Comments are moderated. Only civilised conversation is permitted on this blog. Criticism is perfectly okay; uncivilised language is not. We delete any comment which is spam, has personal attacks against anyone, or uses foul language. We delete any comment which does not contribute to the intellectual discussion about the blog article in question.

LaTeX mathematics works. This means that if you want to say $10 you have to say \$10.