Wednesday, April 22, 2009

Schizoid Policy???? The IMF

In its most recent uttering the IMF chastises governments for having not yet “done enough” in the banking sector. They appear to want three things to be done:

  1. “deal” with toxic assets on banks’ books; and,
  2. shut down insolvent financial institutions; and,
  3. provide additional capital to cushion balance sheets against further loan losses.

which might be fine but finding the dividing line in here is like drawing a knife through a bowl of marbles.

With enough “additional capital” any insolvent bank can be made solvent. If “toxic assets” are the measure of what should be closed then most banks  could be shut down. Bad loans are part of doing business.

Some of these incentives fight one another. If there is a prospect of capital coming to “cushion” bad loans there is a lower incentive to foreclose. If insolvency can be staved off in the same way there is little incentive to close institutions.

The tough part is that some measure of acceptable risk must be developed, bad loans shed down to that level – and if shedding is not enough then closure. Such govt funds as exist might be better targeted at softening the transition costs for consumers of bank services rather than for banks – the producers.

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