Quote:
Originally Posted by Cornstock
Right now the economic trend has been Quantitative Easing (QE) to stimulate the economy. This involves the central bank's buying Mortgage Backed Securities to infuse the market with cash. This isn't a bad idea, but at least in the US, the consequence has run into a political obstacle.
With all of the capital requirement changes that occurred after 2008, banks are required to keep more cash on hand in case of emergencies. Their Tier 1 Capital Ratios for small banks was 5.5-7%, and for large banks it was even less. Now they are required to maintain over 10%.
What this means is that a huge bank with 10s of billions of dollars of assets are no longer allowed to lend those 10s of billions. It is required to be dead money. This added to more stringent requirements in lending, so banks can only lend to superbly qualified businesses/individuals makes for a disaster that was really unforseen.
Money multiplier theory says that a dollar lent can be multiplied something like 27 times. So if a bank is required to keep 30 billion in dead money, this would have otherwise been an 810 billion dollar infusion into the economy, which would have spurred economic growth. (Imagine your small business getting a small chunk if that).
So the banks are taking the money that is being infused by QE and putting it straight towards their reserves, instead of injecting it into the economy. This is why no one has seen any real effect of QE until recently, now that the reserves are topped off and in compliance.
I know no one likes big banks, but they are an integral part of our economy, and by handcuffing them it hurts everyone. But Bernie and the like don't recognize this and just want more regulations. They need to be loosened up so the banks are allowed to lend.
I know this is kind of long, but it may be the first time anyone has explained to you WHY these new bank regulations are so bad, rather than just saying that big banks are bad and greedy and they deserve to be punished.
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This post is riddled with inaccuracies. Capital is not cash on hand. It is a leverage ratio. Small banks have never averaged 5.5-7% tier one capital.
The biggest effect of QE is that it removed toxic and illiquid assets from the books of the largest institutions, which were threatening to create accounting losses for said institutions at the time. This was the huge bailout.
Also, large banks do need to have their leverage constrained because they create multiple layers of leverage by leveraging the holding company, resulting in far lower capital levels. The whole topic is frankly too complicated. That is without even getting into concentration risk management.
Furthermore, there is no formal reserve requirement of ten percent tier one capital. While increased capital levels are being encouraged by regulators, the level of capital is evaluated with respect to the institution's risk profile.
The assumption that reducing the reserve requirement will automatically increase lending is also erroneous. Loan demand has been weak for about a decade now. Furthermore, even if loan demand was stronger, the creditworthiness of borrowers you would be lending to with a lowered reserve would not be nearly as strong. The more competition increases for loans, the more concessions are made by the bank, the more likely the bank is to take losses on that loan.
So rolling back regulations allows for increased malinvestment by institutions that have less capability to absorb those losses. Often time these are exacerbated by a dip in specific types of assets, which is where concentration risk comes in. Sound familiar? Sounds like 2007 to me.