The Game of Bank Bargains

My progress through by Charles Calomiris and Stephen Haber is ever so slow (partly because of the distraction of Chimamanda Ngozi Adichie’s wonderful novel ), but I’m enjoying it a lot.

[amazon_image id=”0691155240″ link=”true” target=”_blank” size=”medium” ]Fragile by Design: The Political Origins of Banking Crises and Scarce Credit (The Princeton Economic History of the Western World)[/amazon_image]   [amazon_image id=”000735634X” link=”true” target=”_blank” size=”medium” ]Americanah[/amazon_image]

Take these two quotations from Chapter One, ‘If stable and efficient banks are such a good idea, why are they so rare?’:

“Banking systems are susceptible to collapse only when banks both expose themselves to high risk in making loans and investments and have inadequate capital on their balance sheets to absorb the losses associated with those risky loans and investments. If a bank makes only solid loans to solid borrowers, there is little chance that its loan portfolio will suddenly become non-performing. If a bank makes riskier loans to less solid borrowers but sets aside capital to cover the possibility that its loans will not be repaid, its shareholders will suffer a loss but it will not become insolvent. These basic facts about banking crises are known.”

So the question about system instability is why are banks allowed to take risks without adequate levels of equity? Of course, Adam Admati and Martin Hellwig asked the same question in their brilliant book .

[amazon_image id=”1480577006″ link=”true” target=”_blank” size=”medium” ]The Bankers’ New Clothes: What’s Wrong with Banking and What to Do about It[/amazon_image]

The chapter concludes:

“The fact that the property rights system underpinning banking systems is an outcome of political deal making means there are no fully ‘private’ banking systems; modern banking is best thought of as a partnership between the government and a group of bankers, a partnership that is shaped by the institutions that govern the distribution of power in the political system…. We call this process of deal making the Game of Bank Bargains.”

Exhibit number one is the stability of the Canadian banking system (zero systemic crises since 1840) versus the instability of the US (12 crises). In this light, it was interesting to read Edward Luce’s strongly worded article on finance and US democracy in this morning’s Financial Times.