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January 10, 2013 11:37 pm
From Dr Eamonn Butler.
Sir, The Basel Committee is wise to give banks more time to strengthen their balance sheets (“Massive softening of Basel bank rules”, January 7). If our aim is to recover from the downturn phase of the boom-bust cycle, then there needs to be enough capital around to convince businesses that they have nothing to fear from investing in the future. With the banks hoarding capital to meet regulatory targets, capital becomes tighter and business confidence remains in self-perpetuating gloom. Only when growth is restored can we afford to divert valuable capital back into bank balance sheets.
In any case, the Basel capital requirements largely miss the point. The key issue is the fractional reserve banking system’s tendency to create money in the boom, when it is not needed, and to destroy it in the bust, when it is. To avoid that destructive monetary amplification we need the banks to be much more conservative.
Demanding that they hold “assets” such as junk sovereign debt or other banks’ liabilities does not achieve that. As we will explain in a report next month, the only solution is to make them hold a lot more cash. And even that requirement should proceed only as quickly as a struggling economy can absorb.
Eamonn Butler, Director, Adam Smith Institute, London SW1, UK
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