Nai-fu Chen (the Paul Merage School of Business, University of California, Irvine, and Center for Advanced Research in Finance, University of Tokyo(Visisting Professor)) Takao Kobayashi (Faculty of Economics, University of Tokyo) Risa Sai (Graduate School of Economics, University of Tokyo)
Abstract
Although bank loans themselves are illiquid because of inside information, most of their cashflows are not. Recent financial innovations allow most bank loans to be liquefied via credit derivatives and actual and synthetic securitizations. The loan originating-monitoring bank holds the remaining illiquid residual tranche that contains the concentrated credit risk and information rent. We find that in securitizing a representative commercial loan portfolio, the average residual tranche is about 3%, which is the "market determined capital" necessary to support the liquefaction. These innovations turn risky bank loans into liquid securities to be funded by institutional investors and non-guaranteed deposits. If we also restrict transaction accounts with access to the payment system to be backed by 100% reserve, the banking system is perfectly safe without sacrificing a bank's traditional financial intermediary role. The idea of "100% money", which is known to be advocated by Irvine Fisher in 1930's, is now revived with the challenge from new financial technologies. The new system is clearly superior to the current disaster-prone convoluted fractional reserve banking system with deposit insurance and moral hazard.
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Publisher Info
Paper provided by CIRJE, Faculty of Economics, University of Tokyo in its series CIRJE J-Series with number
CIRJE-J-166.