I criticised part of an article by Admati & Hellwig a day or two ago. This present article criticises another area of the same article of theirs. A&H’s article is entitled “The Parade of the Bankers’ New Clothes Continues: 31 Flawed Claims Debunked”. No.26 identifies “thin banking” specifically, while 27 refers to FR or something very to what is normally understood by the phrase FR close. In fact the two amount to the same thing.
The only difference is that slim banking BY IMPLICATION leaves financing to entities that are funded by collateral, whereas FR EXPLICITLY does that. I’ll treat the two as a similar thing Thus. What A&H describe as “Flawed claim No.26” is thus. “The ultimate way to make banking safer is to require banks to put funds from deposits into reserves of central bank or investment company money or Treasury Bills (so-called narrow bank or the Chicago Plan for 100% reserve banking).
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“What’s incorrect with this claim? Well it’s quite untrue to say that under FR, “all funds” go into cash or Treasury Bills. The reality is (as mentioned above) that bank or investment company customers / depositors have the CHOICE of placing their money in to ultra safe things like Treasury Bills, or if they want something more risky, that’s up to them. For the “less effective and/or less safe” claim, no attempt is made by the writers to substantiate that claim, so that’s very little use. “If final traders maintain current funding patterns, banking institutions will provide a whole great deal of financing to the federal government; which might well come at the trouble of funding of nonfinancial firms.
So why is A&H believe that most bank or investment company depositors given the decision between the above safe but low interest rate option and the riskier but higher interest yielding option will mainly choose the first? A&H provide no evidence. However, there is in fact some clear evidence. In the case of money market mutual funds in the US which are being forced to obey the guidelines of FR, depositors are opting for the safer option mainly, as it happens. So A&H there are right, but because of all the best rather than good management I suggest. However, that doesn’t get their argument very far.
First, by way of trying to online backup their claim about “connection with southern Europe”, they cite a work I cannot find. Second, the broad claim that more government borrowing suppresses growth obviously does not hold water if government borrowing funds relatively productive infrastructure or other investments. Put another way, if federal government is offering totally safe bonds which account non-viable investments, and which pay a decent interest, and those bonds are safe only because of completely artificial taxpayer support, that’s an obvious fiddle or distortion. I.e. government is making a “too good to be true” offer, and it’s barely the fault of FR if everyone makes a dash for your too good to be true offer.
“Much more likely, thin banking would lead traders to place considerably more of their money in other organizations, for example money market funds (MMMFs) which are “bank-like” without being subjected to the same legislation as banks. As we have observed in the weeks after the Lehman personal bankruptcy, such institutions may also be subject to runs and can be considered a major way to obtain systemic risk.
Well as already intimated, the authors don’t appear to have swept up with the actual fact that (at least in the US), MMMFs are being designed to obey the guidelines of FR. Garages have to obey regulations. If a small firm claims not to be a garage area, when it is quite clearly fixing cars, selling used cars etc, that will not cut any glaciers with garage area regulators, and right quite.
Moreover, quite similar problem applies to A&H’s preferred answer to bank problems: higher capital requirements. That is, if the last mentioned were enforced on banks, do question numerous small “bank-like” entities would try to evade the guidelines. Of course the regulators will never keep tabs on every small shadow bank or investment company, but that doesn’t really matter. One reason is that one of the primary goals of FR is to bar private money creation, and money is by definition anything which is widely accepted in payment for goods and services. And the liabilities of a SMALL shadow bank or investment company aren’t accepted” “widely.
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