JPMorgan has been in all the business headlines owing to its
shocking $2bn trading loss. This has lead to a revival of debates questioning
whether these ‘megabanks’ are actually beneficial to the society. The banks
believe that they bring economies of scale, therefore higher efficiency. The critics
have argued against the high levels of leverage maintained by these financial
institutions and the risks associated with it.
The current crisis has also revealed that very little has
changed following the 2008 global financial crisis. Lessons that should have
been learned have been completely ignored. The recent loss is associated with
trading credit derivatives, almost similar investments were made four years ago
which started the global recession.
Anat Admati, Professor of Finance and Economics at Stanford
Graduate School of Business, asked some tough questions about one and a half
year ago, whose relevance has all the more improved in the wake of the recent
developments.
The questions, with the relevant link to the main article
are posted below.
(i) Is "too
big" the same as "too big to fail?"
(ii) Do capital
requirements force banks to "set capital aside for a rainy day" and
not use it to help the economy grow?
(iii) Are banks
different than non-banks in that high leverage is essential to banks' ability
to function?
(iv) Would terrible
things happen if capital requirements were to increase dramatically?
The first order of
business is to clear the fog and focus on the right things. I will try to
explain. With the basics in place, answers will begin to emerge, or at least
the right questions to ask.
By the way, I answer
an emphatic NO to each of the above questions.
Admati, A. (2010). What Jamie Dimon Won’t Tell You: His Big
Bank Would Be Dangerously Leveraged. The
Baseline Scenario. [Onine]
Your comments and feedback are always appreciated.
Sarfaraz A.K.
