Finance exists to redistribute purchasing power across space and time.
Workers who spend less than they earn on goods and services can use the surplus to buy assets. Once they retire, they can sell those assets to finance consumption spending without having to toil.
Companies have their own life cycles. When young, they issue shares to savers to raise money (and to employees to limit their cash outflows). As they age and their operating cash flows exceed their investment needs, they can borrow against their assets to reward earlier shareholders.
The job of banks, asset managers, insurers, and other financial intermediaries is to create assets for those who want to spend less than they earn and provide capital to those who want to spend more.
These intermediaries are not passive actors simply matching the desires of others, of course, but are for-profit businesses with their own shareholders and workers. This can create tensions between what is best for the financial firms and what is best for the financial system. Choices that can be extremely profitable for workers—such as borrowing heavily to boost short-term returns—can create serious problems for the many users of financial services. Banks that blow up cannot originate loans or maintain the payments system. Insurers cannot honor their obligations to policyholders if their financial bets lead to catastrophic losses.
Regulation and supervision are supposed to prevent these problems. The challenge is making the system safe enough to preserve the core utilitylike functions without being so restrictive as to prevent the financing of worthwhile projects. (One alternative would be to carve out the payments system from everything else.)
Fortunately, the Bank for International Settlements has produced a new comprehensive database of research on the economic consequences of financial regulations. The Financial Regulation Assessment: Meta Exercise database, or Frame, visualizes the range of scholarly opinion. For example, the screenshot below shows that most estimates find bank lending grows faster when banks are less reliant on debt:
The BIS published a paper to accompany the release of Frame as part of its latest Quarterly Review.
Its most novel finding is that banks that primarily fund themselves with customer deposits “do not increase loan growth as much in normal times” compared with other banks but “lend relatively more than other banks during crisis times.” In other words, the minimum “net stable funding ratio” is an especially useful rule for tempering the swings of the credit cycle:
Please play around with the database and let us know if you find any other interesting patterns.
Write to Matthew C. Klein at email@example.com