September 23, 2013

Banks are not looking to maximize risk-returns on loans, but to maximize equity-returns of loans.

Sir, Martin Feldstein in “Why the Fed is wrong to delay the return to normality”, September 23, writes that by “promising to keep the real short-term rate below zero even the economy has returned to full economy… they distort the investment behavior of individuals and institutions, driving them to reach for higher yields by taking inappropriate risks. They lead banks to make riskier loans in order to get higher returns”

Feldstein is right about individuals and institutions, other than banks. Because, as to the banks, these are not searching for higher returns by making “riskier loans”, but to maximize the return on equity by minimizing the capital they need to hold against the loans. It is all about a flight to perceived regulatory safety