Thursday, March 01, 2012
A clockwise day
That is to say, the regular clockwise walk around Horton Lane and Longmead Road without diversions or extensions. Hawthorne buds starting to burst in the Horton Lane hedges. Plus a sprinkling of dandelions, daisies and speedwell. This last having a pretty blue flower but, along with dandelions and daisies, is regarded as vermin in so far as our lawns are concerned.
On return came across an article by Andrew Haldane in the LRB about banks, an interesting article but I am not sure that I am impressed by the author being executive director for financial stability for the Bank of England. Was he off duty went our finance went unstable? Notwithstanding, prompted to make one of my elementary models as a vehicle for further thought.
So let us suppose we have a bank the business of which is to take deposits from one bunch of people and to make loans to another bunch. In the olden days one of the main functions of a bank was to provide a safe haven and depositors would pay for that haven but nowadays depositors generally expect to get paid. So let us suppose that the total deposited is D and that the bank has to pay depositors DI each year by way of interest. Being a model for today we assume that DI is positive. Contrariwise, leaving aside Christian and Muslim subterfuges to avoid being accused of usury, banks have always charged borrowers. Let us suppose that the total lent is L and that the borrowers have to pay the bank LI each year by way of interest. Let further suppose that the bank has cash assets of C and owners O owning shares to the value of the market capitalisation of M. Asset strippers being one of the varieties of sharks than move in when M gets too low. We forget about other assets - buildings, systems, goodwill etc - and operating costs. My understanding of accounting is then that for a solvent bank we should have L+C=D, while M is some function of what the market thinks that the bank will pay in dividends.
We then poke the thing around in various ways.
If all that the bank was doing was providing safe haven then L & LI would be zero, C would equal D and DI would be negative. But apart from providing safe haven, the bank also acts as a sort of unit trust. Depositors get a share of the returns from the pool of lenders, with it being unlikely that many of the lenders will go bad at the same time, with the bank taking most of the risk and with C being the buffer against problems with L. Because O are the ones taking the risk it is fair that while DI is now positive, LI is bigger than DI, with the difference going to O in the form of dividends.
If DI gets bigger than LI and stays that way for any length of time, the bank is bankrupt. This might happen if, for example, a whole lot of L goes pear shaped and has to be written down. Or if L is small because the bank can't find enough proper people to lend money to and resists the temptation to lend money to improper people. Resistance which was broken down in the first instance, I seem to recall, by President Clinton saying that he wanted houses to be built for the people.
If the depositors make a run on the bank and D falls rapidly, the bank may exhaust C before they can liquidate enough L to pay out the depositors. Again, the bank is bankrupt.
Haldane makes the point that once upon at time O had unlimited liability to meet the D flavoured liabilities, a fact which made O pay serious attention to what the bank was doing, rather than just letting the hired help get on with it. Banks tended to be more conservative than they are now with L a much smaller multiple of C. Maybe as low as 1 or 2 rather than the 20 that we peaked at just before the crash.
He also makes the point that not only is L a large multiple of C, it is also a large multiple of the GDP of the country in which the bank is registered. So a relatively small percentage loss on L might mean that digging the bank out of bankruptcy might easily engulf the host. Making banks smaller does not necessarily remove this risk: if all the small banks get into the same fix at the same time, fixing them all costs just as much as fixing one big bank.
All of which leads back to something that I have been suspecting for some time. Small countries should not be in the business of hosting big banks which run big risks if hosting is to include underwriting their losses. So, at some point the centre of gravity is going to move away from London to some place where the real money is.
Small countries should only host big banks which do not run big risks. Whose L is good and safe. Banks which exist more to provide serviced safe havens for the man & company in the street than to provide loans to grand & dodgy projects in far flung jungles. Or to grand & grossly overvalued housing estates nearer home. Perhaps in Ireland.
Against all this one might argue that C is dead money. Gold sovs. under the mattress. One wants to turn as much of C into L as possible so that it supports LI. That is where all the wealth comes from. At which point it is clearly time to turn into TB.
On return came across an article by Andrew Haldane in the LRB about banks, an interesting article but I am not sure that I am impressed by the author being executive director for financial stability for the Bank of England. Was he off duty went our finance went unstable? Notwithstanding, prompted to make one of my elementary models as a vehicle for further thought.
So let us suppose we have a bank the business of which is to take deposits from one bunch of people and to make loans to another bunch. In the olden days one of the main functions of a bank was to provide a safe haven and depositors would pay for that haven but nowadays depositors generally expect to get paid. So let us suppose that the total deposited is D and that the bank has to pay depositors DI each year by way of interest. Being a model for today we assume that DI is positive. Contrariwise, leaving aside Christian and Muslim subterfuges to avoid being accused of usury, banks have always charged borrowers. Let us suppose that the total lent is L and that the borrowers have to pay the bank LI each year by way of interest. Let further suppose that the bank has cash assets of C and owners O owning shares to the value of the market capitalisation of M. Asset strippers being one of the varieties of sharks than move in when M gets too low. We forget about other assets - buildings, systems, goodwill etc - and operating costs. My understanding of accounting is then that for a solvent bank we should have L+C=D, while M is some function of what the market thinks that the bank will pay in dividends.
We then poke the thing around in various ways.
If all that the bank was doing was providing safe haven then L & LI would be zero, C would equal D and DI would be negative. But apart from providing safe haven, the bank also acts as a sort of unit trust. Depositors get a share of the returns from the pool of lenders, with it being unlikely that many of the lenders will go bad at the same time, with the bank taking most of the risk and with C being the buffer against problems with L. Because O are the ones taking the risk it is fair that while DI is now positive, LI is bigger than DI, with the difference going to O in the form of dividends.
If DI gets bigger than LI and stays that way for any length of time, the bank is bankrupt. This might happen if, for example, a whole lot of L goes pear shaped and has to be written down. Or if L is small because the bank can't find enough proper people to lend money to and resists the temptation to lend money to improper people. Resistance which was broken down in the first instance, I seem to recall, by President Clinton saying that he wanted houses to be built for the people.
If the depositors make a run on the bank and D falls rapidly, the bank may exhaust C before they can liquidate enough L to pay out the depositors. Again, the bank is bankrupt.
Haldane makes the point that once upon at time O had unlimited liability to meet the D flavoured liabilities, a fact which made O pay serious attention to what the bank was doing, rather than just letting the hired help get on with it. Banks tended to be more conservative than they are now with L a much smaller multiple of C. Maybe as low as 1 or 2 rather than the 20 that we peaked at just before the crash.
He also makes the point that not only is L a large multiple of C, it is also a large multiple of the GDP of the country in which the bank is registered. So a relatively small percentage loss on L might mean that digging the bank out of bankruptcy might easily engulf the host. Making banks smaller does not necessarily remove this risk: if all the small banks get into the same fix at the same time, fixing them all costs just as much as fixing one big bank.
All of which leads back to something that I have been suspecting for some time. Small countries should not be in the business of hosting big banks which run big risks if hosting is to include underwriting their losses. So, at some point the centre of gravity is going to move away from London to some place where the real money is.
Small countries should only host big banks which do not run big risks. Whose L is good and safe. Banks which exist more to provide serviced safe havens for the man & company in the street than to provide loans to grand & dodgy projects in far flung jungles. Or to grand & grossly overvalued housing estates nearer home. Perhaps in Ireland.
Against all this one might argue that C is dead money. Gold sovs. under the mattress. One wants to turn as much of C into L as possible so that it supports LI. That is where all the wealth comes from. At which point it is clearly time to turn into TB.
# posted by Jim @ 6:39 AM 
