There really are iron rules in economics

There has been fierce criticism of the EU for making matters worse by forcing lenders to raise core tier one capital ratios to 9pc by the end of this month, a move widely blamed for tipping the eurozone back into slump.

Global regulators signalled a change of course yesterday, exploring ways to broaden the range of assets that count as liquid reserves. Critics say the whole policy of regulatory overkill should be abandoned until recovery is secure.

As in, you cannot expand bank lending and thus credit and the money supply, at the same time as you are insisting that banks double or triple their capital margins.

It\’s just not one of those combinations available to you.

Generals and last war all over again. Yes, the capital fragility of the banks was a problem. Almost certainly will be in hte future as well. But currently we\’ve an entirely different one: that shrinking money supply.

6 thoughts on “There really are iron rules in economics”

  1. I would not say that is an iron rule of economics at all.

    Take “Core tier 1 ratio” = equity / total assets, though I think under Basel it should be risk-weighted assets. Maybe Ms Coppola will slap me down.

    Say you have equity = £100, assets = £1000, CT1 = 10%

    If you fund £100 of new assets from £100 of new equity, you now have:

    £200/£1100 = 18% CT1 ratio

    But you might then ask why equity investors don’t want to fund new bank lending, or why banks do not want to raise new equity. Which are good questions.

  2. Considering that the bank collapse was a bit of a Black Swan affair, we are probably better off ignoring the demand for banks to increase their reserves and get them to lend. When we have recovered a bit and are on the way to good growth, then is the time to start saving up for the next rainy day.

  3. Critics say the whole policy of regulatory overkill should be abandoned until recovery is secure.

    So when the recovery is secure overkill will be ok? I don’t think the author thought that sentence through.

  4. “We have run out of options. The Europeans have to display their awesome firepower”

    Comedy gold 🙂

  5. The Europeans have to display their awesome firepower

    Ah, missed that. The Dutch and the Belgians won’t play over the weekend. The French have some, but it is incompatible with everybody else’s. The Germans have the best stuff but aren’t allowed to use any of it outside the Fatherland.

    Hey – it works for money too!

  6. Gareth

    yes, it is risk weighted assets. But if you assume that the new assets in your example are UK gilts it all works out fine – they are assumed to be risk free so do not require capital allocation.

    Your questions are the wrong way round. Equity investors don’t want banks to raise more equity because it dilutes their holding and diminishes their returns. Banks don’t want to lend because it ties up scarce capital.

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