Ending the Sugar-Rush from Candy-Floss Credit

In an article for Critical Reaction, Graham Stewart highlights some of the challenges the Regulation of Deposits and Lending Bill may face:

there are obvious objections to the proposals, not least that this well intentioned effort to restore sound finance could prove so deflationary that it seriously retards the economy and thereby further destabilises the nation’s already precarious accounts. Vehement opposition can be expected by the major high street banks, drawing in turn calls for them not to be undermined by some and by cries that they’ve brought this situation upon themselves by others. Would the Carswell-Baker Act (as we might call it) cripple the UK’s banking sector if international competitors did not follow suit and carried on regardless? In the short term at least, the prescription for financial rectitude may prove a more painful cure than merely enduring the illness.

Other concerns involve trying to foresee the response of depositors if they were given the choice to opt out of allowing their bank to invest their money according to the bank’s preferences. Those who chose not to see their money used for other investment purposes would see their accounts ceasing to pay interest and would incur greater handling costs. Might some small savers balk at paying higher bank charges and therefore stick their savings under the mattress instead? In such ways might imprudence rather than financial savvy result.

Nevertheless, what Douglas Carswell proposes should be the basis for serious debate. On Wednesday his bill passed its first reading without dissent. The second reading debate will take place on 19 November at which point we can expect the legislation to hit the parliamentary buffers. But the fundamental questions that underpin his proposal will remain in need of better answers than have thus far been offered by the defenders of the status quo. In recessions the magic by which a depositor’s money may be invested elsewhere yet still withdrawable on demand loses its potency. For it is at such times that we discover that (at the banks’ current ratio of being thirty times leveraged), for every £1 held by British banks, there are 30 different depositors laying claim to it. That is rather a lot of different places for £1 to exist at any one time.

The whole article is well worth reading.

1 Comment

  • Tyler says:

    How many times do people need to get this wrong?

    Leverage ratios and how many times deposits have been circulated via fractional reserve banking are NOT the same thing.

    Banks may well be leveraged 30 times. This comes from OTHER banking assets/liabilites….NOT the deposit/lending business (which typically generates about a 5x leverage).

    Fractional reserve banking with a 10% reserve (which is less than normal) can mathematically ONLY create a 9x leverage. Typcially a bank will “lend out the same pound” only 4-9 times.

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