Wednesday, October 19, 2011

A Quick Lesson in Banking Realities

From Open Europe news summary:

In the FT, Patrick Jenkins argues that new bank core tier one capital ratios of 9% could lead to reduced lending. He explains that several big banks across Europe have made clear that they will reduce lending commitments rather than raise additional capital in order to meet new EU capital requirements.
FT: Jenkins

A capital ratio is simply the capital account divided by total assets. As every school child knows (or should know!) the ratio can change from either a change in the numerator (capital), a change in the denominator (total assets), or a change in both. If government mandates that banks maintain a higher ratio, banks may choose to decrease the denominator (total assets) instead of increasing the numerator (capital). They would decrease total assets by reducing lending; i.e., not only refusing to make new loans but also refusing to renew existing loans. In today's money environment in which governments manipulate interest rates and change banking regulations as their whim strikes them, the market for new capital issues cannot be very attractive. Why risk more capital in such an environment?

1 comment:

  1. Hi Pat,

    I'm a former student of yours from your first class of Austrian Economics at Iowa a few years ago. I just happened to find your blog via the Mises website, and wanted to thank you for being a great teacher. In the one semester that you were my teacher, you forever changed my views and outlook on every aspect of economics. Hope all is well! Keep up the great work.

    -Jeff Austin