by The Compliance Exchange on October 9, 2012
A new study by economists Arnoud Boot at the University of Amsterdam and Lev Ratnovski at the International Monetary Fund finds that recent blow-ups in the banking sector – JPMorgan Chase’s $6.8 billion “London Whale” losses and that whole financial-crisis thingy, to name two — are not isolated events, but “a sign of deeper structural problems in the financial system.”
The only prescription? Less trading by big dumb banks.
“Without policy action, crises associated with trading by banks are bound to recur,” Boot and Ratnovski write in a blog post about the paper. “Even strong supervision will not be able to prevent them. Consequently, it appears necessary to restrict trading by banks.”
Why can’t banks just trade like George Soros and everybody else? Why can’t they have any fun?
First, banks have tons of capital laying around, relative to, say, a hedge fund, which specializes in trading. The bigger the bank, the more capital. A bank would almost be crazy not to gamble with that capital to make more profit. That’s especially the case in economic environments like, say, a crappy recovery from the worst recession since the 1930s, when interest rates are at rock-bottom and banks are afraid to lend money. With their share prices crushed, regulators banging on the door and the government making loud noises about how they’re not going to bail out any more banks, it’s all too tempting for a bank to take some of that extra money it has laying around and take it down to the pari-mutuel betting parlor.
“As a result, banks trade too much, and in… too risky a fashion, compared to what is socially optimal,” Boot and Ratnovski write.
Read the full story at the Huffington Post.
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