4 Dec 2011

The stupidity of bank lending regulations

One of the many insights that I got by reading the excellent "Where does money come from" was the discovery of the reason why housing is now unaffordable for the vast majority of the population. On page 97, the book explains how banks decide whether or not to use their licence to create money out of thin air by allowing people (or companies, or countries) to take on debt. Here's what they say.
In the current system of regulation, loans are given a risk weighting depending on how risky the regulators perceive the loan to be. Business loans are given a 100 per cent risk weighting, meaning that for regulatory purposes, the level of captial currently required must be 8 per cent of the value of the loan.....
So, if a business borrows £1,000, £80 of captial must be kept aside for a capital requirement of 8 per cent. Mortgages are given a lower risk weighting, as the house can be sold to someone else if the homeowner cannot pay. Mortgages are currently weighted at 35%. This means that a £1,000 morgage would only rquire £28 of capital (£1,000 x 35 per cent risk weighting x 8 per cent capital ration), which is the same level of capital that a £350 business loan would require. From this it follows that unless a business loan makes three times as much profit as a mortgage, the bank will prefer to extend mortgages.
So, there you have it. That is why house prices have gone through the roof over the last couple of decades, and why businesses get charged excessive interest rates. Banks have been throwing money that they didn't have at people to buy property - much more rewarding than investing in the real economy. And of course, if the banks can speculate on the foreign exchange markets with their money (over 1.8 trillion dollars a day in the UK alone), and can make even more money that way, businesses in need of loans to develop can forget it.

Difficult to find a better reason for introducing the 0.1% FTT on foreign exchange to "encourage" banks to do something productive with their resources.

No comments:

Post a Comment