Monday, 17 March 2014

The problem in requiring banks to have more equity: Charles Goodhart has the answer

My friend Matt makes a very good point taken up here by Charles Goodhart in his review of Adamti anad Hellwig's book, in Economica, 2014, V81, pp. 390.

Here's the background:

So here's the problem. Suppose banks hold £2 of equity on assets of £100, a 2% ratio.  Suppose they are required to hold 20% of equity.  Easy!  Just reduce lending to  £40!  Goodhart again:

The suggested answer: