Bank Lending Pathetic

Banks are highly regulated institutions, and so they respond to regulators. A friend shares with me the following anecdote. He thinks real estate is cheap, and wants to buy houses, and make money renting them. Ultimately, he would sell out of the homes when they recover in value. He has been doing it for a couple years with good results. He went to a bank, to see if he could leverage this idea, say by getting loans for 50% of the purchase price. They said, only if you hold this in a ‘compensating balance.’ These are cash balances held by the borrower at the bank, and add fees and some safety to the bank. In this case, the bank wants the borrower to keep the entire balance as a cushion, borrow money for a potential liquidity event, that would be rather futile because once the borrower used said compensating balances to rectify a funding problem, it would then have a liquidity problem with the bank. So, in practice, the compensating balance would not be a cushion for tough times, nor would it earn interest for the borrower. My friend decided not to get the loan.

The regulators aren’t letting bankers return to business as usual, and most observers still think the bankers basically are parasitic thieves. I maintain that without a healthy bank sector free from the fear of extinction, our recovery will remain weak.

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About Eric Falkenstein 136 Articles

Eric Falkenstein is an economist who specializes in quantitative issues in finance: risk management, long/short equity investing, default modeling, etc.

Eric received his Ph.D. in Economics from Northwestern University , 1994 and his B.A. in Economics from Washington University in St. Louis, 1987

He is the author of the 2009 book Finding Alpha.

Visit: Eric Falkenstein's Website

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