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]
Link: Click Here. (Opens in New Window)
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