Outrage! Outrage!

Their recklessness has bordered on the criminal. One figure from the Bank of England\’s financial stability report last October exemplifies the enormity of their folly. In 2000, the amount of money held on deposit in British banks and the amount they were lending was roughly comparable. Last year, they were lending £700 billion more than they were receiving.

This is a common criticism at the moment and I\’m really not sure why people are getting so angry about it.

First though, of course the banks were not lending more than they were receiving. They were lending more than what they were receiving from their depositors, this is true. They were borrowing the excess from the wholesale markets, not creating the £700 billion out of thin air.

It\’s also true that such reliance upon the wholesale or interbank markets made a bank run, if one was to happen, quicker to happen. It might even be said that, in retrospect, it wasn\’t all that good an idea.

But outrage over this? This I don\’t get. There\’s one thing a bank does. It borrows short and it lends long. That\’s it: anyone who borrows short and lends long is a bank and borrowing short and lending long is what a bank does.

Whether you borrow from you and me through the mechanism of a current or deposit account or whether you borrow for 24 hours, 180 days or a year through the interbank market doesn\’t change this basic point. And you\’re still liable to a bank run if people who\’ve lent to you short want their money back faster than you can get it back from those you\’ve lent it to long.

That is, every bank faces liquidity risk if confidence flees. There is no way of being a bank and not facing this risk. Because, to be blunt about it, shouldering this risk is what banks are for.

So, to be outraged that banks were shouldering such risk is simply ignorant.

I agree that it all doesn\’t seem to have worked out very well (that British understatement, don\’t you love it?) but to be outraged that, umm, banks are banks, seems odd. I\’m sure we\’ll find all sorts of things that we can criticise banks and bankers for but I just don\’t think that borrowing short and lending long is one of them.

4 thoughts on “Outrage! Outrage!”

  1. Do you not mean illiquid, rather than insolvent? I agree that they are probably all insolvent, as well, but it’s not true of all banks, at least normally. That was the kind of point of central bank funding, and I’m sure you were saying ‘this is a crisis of illiqudity not insolvency’ back in October 07 [not that you were to know what was coming, of course]

    Tim adds: Yes, you’re right, I do. Fixed now.

  2. Absolutely. Their problem was lending too much at too low an interest rate (i.e. mispricing risk) and having inadequate reserves (even if these met the requirements of BoE, FSA, Basel etc). Banks hate holding large reserves as it hurts their profits in the boom years. That’s worked out really well for the shareholders recently…..

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