What are the limits on Commercial Bank Lending?
Analysis of the 2007-8 credit crisis has concentrated on issues of relaxed lending standards, and the perception of irrational behaviour by speculative investors in real estate and other assets. Asset backed securities have been extensively criticised for creating a moral hazard in loan issuance and an associated increase in default risk, by removing the immediate lender's incentive to ensure that the underlying loans could be repaid. However significant monetary issues can accompany any form of increased commercial bank lending, and these appear to have been overlooked by this analysis. In this paper we propose a general explanation for credit crises based on an examination of the mechanics of the banking system, and in particular its internal controls on the supply of credit. We suggest that the current credit crisis is the result of multiple failures in the Basel regulatory framework, including the removal of central bank reserve requirements from some classes of deposit accounts within the banking system, allowing financial instruments representing debt to be used as regulatory capital, and in particular the introduction of securitized lending which effectively removed a previously implicit control over the total quantity of lending originating from the banking system. We further argue that the interaction of these problems has led to a destabilising imbalance between total money and loan supply growth, in that total lending sourced from the commercial bank sector increased at a faster rate than accompanying growth in the money supply. This not only created a multi-decade macro-economic debt spiral, but by increasing the ratio of debt to money within the monetary system acted to increase the risk of loan defaults, and consequentially reduce the overall stability of the banking system.
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Cara Lown & Stavros Peristiani & Kenneth J. Robinson, 1999.
"What was behind the M2 breakdown?,"
Financial Industry Studies Working Paper
99-2, Federal Reserve Bank of Dallas.
- Cara S. Lown & Stavros Peristiani & Kenneth J. Robinson, 1999. "What was behind the M2 breakdown?," Staff Reports 83, Federal Reserve Bank of New York.
- Joshua N. Feinman, 1993. "Reserve requirements: history, current practice, and potential reform," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Jun, pages 569-589.
- James H. Stock & Mark W. Watson, 2003. "Has the Business Cycle Changed and Why?," NBER Chapters,in: NBER Macroeconomics Annual 2002, Volume 17, pages 159-230 National Bureau of Economic Research, Inc.
- James H. Stock & Mark W. Watson, 2002. "Has the Business Cycle Changed and Why?," NBER Working Papers 9127, National Bureau of Economic Research, Inc.
- Simon Wolfe, 2000. "Structural effects of asset-backed securitization," The European Journal of Finance, Taylor & Francis Journals, vol. 6(4), pages 353-369. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:arx:papers:0904.1426. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (arXiv administrators)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.