It is a fairly basic point

All parts of the “grand plan” are flawed in some degree. Requiring the banks to address underlying problems of solvency by holding bigger capital buffers suffers from the obvious drawback that banks might choose further to contract their lending rather than raise more capital, thereby worsening the economic crisis. Many have already warned that this is precisely what they will do.

Rather difficult to both increase capital buffers and lending at the same time.

Doesn\’t stop people calling for it of course……

2 thoughts on “It is a fairly basic point”

  1. That’s because people think that in order to get banks to lend, all you have to do is ensure they have lots of cash. And Trichet is doing that, isn’t he? As are the Bank of England, and the Fed, of course.

    People don’t nderstand that lending is capital-constrained, not reserve-constrained. This confusion is not helped by the fact that many journalists don’t understand the difference between reserves and capital, so frequently talk about banks needing to “hold more cash” when they actually mean “increase their capital”.

    But the underlying, pervasive error that just about everyone seems to make is assuming that banks will always lend if they have the means to do so. Lending is a commercial decision: if banks don’t want to lend, they won’t, however much cash and capital they have. And, of course, they have to have credit-worthy customers to lend to…..but that’s a whole new issue!

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