Understanding banking mechanics isn’t sexy; but it is essential

Banking and finance blogging seems to attract a lot fewer readers than economics blogging. This is unfortunate.

Boring

It sounds boring and too technical. The terms used to describe banks’ characteristics are mostly ignored by the wider public, and even by many more informed people and economists. Ask the layman what a leverage ratio, a Tier 1 ratio or NPLs are, and you will be met with raised eyebrows. In contrast, GDP, NGDP/aggregate demand, opportunity cost, inflation/CPI, money supply and so forth, are much more wildly known (not enough many would argue, and I’d agree).

Some would reply that economic terms are more ‘important’ in order to understand how the world works. Fair enough. Still, jargons in other industries are also relatively broadly known: horsepower, torque, medical terms, megabyte, dB, resolution, kWh…

Banking seems to be one of the few exceptions. Here again, some would reply that this is not such an issue, as banking is regulated, and supervisors that are more knowledgeable are in charge of monitoring banks. And I would have to strongly disagree.

It is crucial that the public understands at least some basic banking mechanics. Not doing so creates a number of issues. First, moral hazard: it is well-researched that deposit insurance led to banks free riding on depositors’ blind belief that their money was in safe hands. The same reasoning applies to leaving regulators in charge of the monitoring of the financial system. Second, it leaves an open door to politicians and regulators to manipulate the industry through various legislative acts.

And don’t tell me that understanding a leverage ratio or a loan loss coverage ratio is a lot more difficult than understanding broadband speed, computer memory, or fixing a car engine. Moreover, the public can nowadays rely on specialised magazines and websites to test and give awards to the best consumer products. Banks could be reviewed in a similar way and rating agency reports be made much more widely available. Banks could start advertising their strong capital ratios rather than merely their ability to allow you to make cheap payments while travelling abroad.

So banking is viewed as boring. Unsexy. And regulations introduced decade after decade are partly to blame for that as they have shielded the broader public from the need to understand the institutions with which they placed their money.

But understanding banking mechanics and regulation is also crucial. It is crucial because the financial system is the heart of the economic system: it allocates loanable funds to sectors and customers that are likely to generate the most economically efficient outcomes. As such, it is intimately linked to the economic subject as a whole, despite some economists begging us to stop talking about banking. When this mechanic is disrupted by new frameworks of rules, the whole economy is affected and either doesn’t produce optimally, or worse, generate malinvestments by not producing the goods that the public want in the long run. And crises ensue.

Free Banking scholars have demonstrated that many of the 18th and 19th century crises had roots in misguided banking rules. The same applies today. One cannot understand our most recent crisis, and possibly our future crises, without knowledge of the small and dull bits that currently dictate, or at least strongly influence, capital flows. As much as ‘macro’ is sexy, the devil is in the details.

I know my work will remain ‘niche’. It is clear that my most successful blog posts have so far treated relatively non-technical topics or banking framed within a more general economic view. But I’ll keep producing ‘niche’ posts nevertheless; because it is necessary. I’ll keep pushing to make readers understand how much they’ve been scr**d by what seems, at first glance, boring details of financial regulation.

Sadly, those boring details may well trigger the next crisis, and make us lose our job.

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5 responses to “Understanding banking mechanics isn’t sexy; but it is essential”

  1. Jake says :

    Keep it up.I enjoy your blog.The awareness of technical mechanics is this blogs strength.

    Have you come across Murray Rothbards:The Myth of Free Scottish Banking;he asserts that Scottish banking was unstable(because it wasn’t actually free)

    PS what books would you recommend,

    • Julien Noizet says :

      Jake, thanks for the kind comment.
      Yes I did, as well as Larry White’s response (which I can’t seem to find online right now, although you can find a different response to a different critique here: https://analyseeconomique.files.wordpress.com/2011/10/reply-to-a-dissenting-view-lawrence-white.pdf)

      Are you referring to books specifically about banking?

      • jake says :

        Thanks for Larry white’s piece.Yes specifically on Banking.I am currently working through Basil j moore’s Horizontalists and Verticalists )…..I was going to going to start Rothbard’s ‘The mystery of Banking’ but then I read that Selgin dismisses his work.

      • Julien Noizet says :

        The Mystery of Banking is a relatively good and simple introductory work. It covers most of the basics, and there isn’t too much controversial about it, if one excludes Rothbard ‘fractional reserves is a fraud’ thing (at least as far as I can remember, as I read it four years ago or so).
        But if you want to know more about banks of issue, there are other interesting, and sometimes more complex, historical and theoretical works.
        I was planning to write a post about my favourite books about banking and money. Perhaps I should work on it sooner rather than later.

  2. Jake says :

    Yes that would be very interesting and much appreciated.

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