The Reserve Requirement Balancing Act

Posted on Friday, September 10, 2010

In addition to Frank Dodd Act reforms, banks will be contending with Basel reforms international regulators are considering which could increase reserve requirements. That means how much money bank need to keep on hand to protect them from losses. The more the banks need to hold, the less the taxpayers may be on the hook if a bank fails. But the issue extends to other businesses doing essentially the same thing as banks, the so called shadow bankign system. And whank banks need to keep more in reseres, there's less they can lend out - a problme we dont need to increase just now. One idea being considered in Basel is a 'bail in' whereby bank creditors will be on the hook instead of tax payers (essentially banks are allowed to count the debt to these creditors as reserves).

Banks meet capital ratios in 3 basic ways; retain earnings, raise more money from investors or lend less. Beacause they can deduct interest on debt but not on dividend, debt financing may be mroe attractive in some cases. And argueably the fact that investors benefit from tax advanatges (until the 2003 cut expire) on dividends and camptal gains encouages them to invest in banks.

Its all a balancing act on so many levels.

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