The Bankers' New Clothes: What's Wrong with Banking and What to Do about It

By Anat Admati; Martin Hellwig | Go to book overview

TEN
Must Banks Borrow So Much?

The Phoenicians invented money—but why so little of it?

Johann Nepomuk Nestroy (1801 –1862), Austrian playwright

AS WE SAW IN CHAPTER 4, banks benefit the economy by taking deposits and making loans. Of these two activities, deposit taking is unique to banks. Loans can also be made by any other institution that has the capacity to assess the loan applicants’ creditworthiness and to monitor their performance. The concentration of banks on lending is due to the ready availability of funds from deposits.1

As we also saw in Chapter 4, banks provide depositors with important services, such as making payments and standing ready to provide cash at any moment. Because deposits are a form of debt, borrowing is an essential part of banking. Does this mean that banks would provide fewer benefits to the economy if they relied less on borrowing and used more equity? The answer is “No.”

Banks have always been fragile and prone to trouble. The very word bankruptcy, common to many languages, alludes to banks.2 The history of banking has been full of crashes and crises. The period between 1940 and 1970, when there was hardly a banking crisis and few bank failures, was a remarkable exception.3 The incidence of crashes and crises since 1970 is not much different from past experience of financial instability, for example, in the nineteenth century.4

Banking experts often start from the observation that, with their reliance on deposits, banks have always been susceptible to runs, and they conclude that fragility in banking is inevitable. By this account, banking crises are similar to natural disasters such as earthquakes or hurricanes, which cannot be

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The Bankers' New Clothes: What's Wrong with Banking and What to Do about It
Table of contents

Table of contents

  • Title Page iii
  • Contents vii
  • Preface to the Paperback Edition ix
  • Preface xiii
  • Acknowledgments xvii
  • One - The Emperors of Banking Have No Clothes 1
  • Part One - Borrowing, Banking, and Risk 15
  • Two - How Borrowing Magnifies Risk 17
  • Three - The Dark Side of Borrowing 32
  • Four - Is It Really "A Wonderful Life"? 46
  • Five - Banking Dominos 60
  • Part Two - The Case for More Bank Equity 79
  • Six - What Can Be Done? 81
  • Seven - Is Equity Expensive? 100
  • Eight - Paid to Gamble 115
  • Nine - Sweet Subsidies 129
  • Ten - Must Banks Borrow So Much? 148
  • Part Three - Moving Forward 167
  • Eleven - If Not Now, When? 169
  • Twelve - The Politics of Banking 192
  • Thirteen - Other People’s Money 208
  • Notes 229
  • References 337
  • Index 363
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