Re: First Great Western want franchise review


I admit it has never occurred to me until recent events
that banks borrow money from each other. I suppose I
assumed that a bank simply made loans from the money
placed there by its depositors. Naive, eh?

The problems are cashflow and interest rates. I can accept £1000 from
depositors and lend out £500, but if the depositors ask for £501 back
I've got a problem. And if I were to retain 50% of the deposits as
cash, the best interest rate I can pay my depositors is half of what I
charge my borrowers, less my overheads, less provision for risk.

The former problem explains inter-bank lending. You can only fix
this if every twenty-five year mortgage is backed by people depositing
money on twenty-five year bonds. The second problem explains why even
50% would be a very low lending ratio, and in a competitive
environment explains why money flows to banks that take more risks,
and why deposit insurance schemes encourage banks to behave badly.

If there were no compensation for depositors when banks fail, people
wouldn't have put their money in Icelandic banks: five minutes'
examination would have shown their lending was unsustainable (although
the CDS system has pretty much failed, that the CDS rates for the
Icelandic banks were about five times those of comparable institutions
told you that the smart money had already left town). Spotting that
Northern Rock was unsustainable would have been harder (its lending
was sound, and its reliance on wholesale money not obviously unwise),
but in the absence of protection a system of ratings would arise, as
would an insurance-based system of protection.

ian


.

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