Tuesday, August 27, 2013

Why We Won't Be Able To Avoid The Next Banking Crisis

Most businesses prefer to raise capital by issuing equity.  During a downturn they do not have to worry about servicing debt.  This makes them less vulnerable to failure.  Banks do the opposite.  They would rather borrow money to finance their operations than issue equity.  The executives are rewarded for increasing the return on equity.  Therefore, the decision is simple for them.  That leads them to take on risks, however, that cannot be absorbed.  This will result in a future banking crisis that economists will not be able to predict.  Governments in the US and UK have been willing to accept this risk.  They do so because the banking lobby has excessive influence on government policy.  Efforts made by academicians to increase the use of bank equity have been futile.

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