December 10, 2012

Now banks do not just search for yields, but for what these yields produce in returns on their equity.

Sir, Tracy Halloway, in “US banks in fresh structured finance spree”, Monday 10, refers to analysts saying “that banks have been snapping up higher-yielding structured securities to offset the effect of low interest rates.”

That is not entirely correct, what banks are searching for is just not higher yields, but higher yields in relation to the bank capital they need to hold. In other words they are searching for the highest possible returns on equity, and that is why unrated borrowers like small businesses and entrepreneurs have such a rough time competing for access to bank credit.

You see even though these “risky” borrowers have never ever really caused a bank crisis, the regulators decided that the banks needed to hold much more capital when lending to them than when investing, for instance, in structured securities sometimes very difficult to understand. Sounds crazy? Yes, it absolutely is!