There has been major debate lately regarding the financial stability of the banks. Given the large bail out of the banks coming from taxpayer money and the massive under capitalization of some of the major banks it is apparent that there is a huge need for change in some of the bank’s capital reserve structures. The banks have been getting pressure from the “Basel Committee on Banking Supervision” to increase reserves and prevent another hit to the global financial system. Currently banks are required to hold 7% of their assets in reserve and they plan on increasing reserves to 8% – 9.5% total and to implement the change over a 3 year term. Based on the massive bail outs that previously happened this does not seem like near enough of a reserve and more of a political ploy to show that they are trying to make a change to benefit the global financial system. While I agree this is a step in the right direction I do not believe it is anywhere near enough.
These kind of reserve requirements are not sufficient due to the fractional reserve banking system whereby a bank takes in customer deposits, takes out a reserve and then loans out the remainder which in turn artificially increases the money supply.
For example, if you deposit $100 in a bank, the bank is only required to keep a small portion (say 20% or $20) in reserves. The remaining $80 is lent out to another person. Now that money is deposited into another bank that keeps a reserve (say 20% or $16) and loans out $64. That means out of the original $100 deposit there is a total of $36 in reserves ($20 + $16) and $144 lent out ($80 + $64). So instead of the $100 deposit the banks have created $180 of money supply into the economy.
This is a HUGE issue because this is how the banks got in trouble in the first place, loaning more money than their balance sheet can support if there are any problems. Plus it causes inflation due to an increase in money supply. Yes an increase in money supply can help the economy function but at what cost? Based on my experience in real estate and investment lending and assessing risk associated with those investments, I can tell you that the banks are not assessing risk correctly. They are over leveraging and the government is backing them (aka we as tax paru millions, and the government said that if you lose the billion they would bail you out with no legal implications, what would you do? In fact this is exactly what the banks did and they were bailed out, except they found a way to make profits off of the entire situation at the same time. So not only did they lose the taxpayers money through the bail out, they are making even more money on the bailout itself. There is something intrinsically wrong with this system and it needs to be changed in order to have a stable future global economy.
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