Banks are the problem: CLOs could be the solution

By Joe Pimbley

Tuesday, August 03, 2010

No bank would be too big to fail if banks were banned from using deposits to fund lending

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Comment by: Anonymous. Posted 9 years ago [2010-08-13 15:47:23]

Joe makes a very poignant and incisive point and I’m in complete accordance. Banking has changed markedly in the past forty years. The ‘traditional’ business of effecting payments, taking deposits and making advances has been replaced as the predominant activity by the provision of financial risk management services and products. By predominant I mean that these latter activities dominate the banking culture rather than constitute the majority of assets of the banking system. The CLO "technology" as described is one of the principal methods of provision of financial risk management services. Associated with this shift, there has been a shift towards increasing use of collateral security, including private assets, as for both funding and the derivative contracts involved. By changing the nature of the balance sheet of the banks in terms of more equity infusion, as a form of leverage reduction seems to be the most a common sense thing to do, but in practice it won’t be a lucrative business for the banks in general.

Comment by: Joe Pimbley. Posted 9 years ago [2010-08-10 10:45:22]

Interesting questions! I'd expect there will always be players who want to sell the "liquidity options" to get the immediate positive carry (of borrowing short and lending long). Examples are ABCP conduits and SIVs that issue CP. There's nothing wrong with knowledgeable issuers and investors making these choices. What we wish to avoid is government insurance and futile regulation.

Comment by: Fishknife -. Posted 9 years ago [2010-08-09 14:35:53]

This is a bold idea which is either utterly flawed or brilliant. The dominant form of finance throughout history has been "banking", that is, selling mispriced liquidity options to depositors. But does it have to be that way? If we stop banks making a living by dancing on the edge of a knife, will a safer dominant form of finance emerge? Or will the liquidity risk simply move somewhere else?