Thursday, January 08, 2009

Why banks still won't lend

People may be wondering why banks won't make new loans even after their respective governments have made multibillion dollar investments, allegedly freeing up capital to lend. This Businessweek article explains why. Basically, banks can't simply loan out $1 for every $1 of capital they receive. They need to maintain an allowance for bad loans, write-downs, etc.

Additionally, banks had been loaning out too much money in the past, because they were able to use a lot more leverage (debt) than they had the right to. Expecting them to return to their old standards isn't reasonable.

Now that their balance sheets are weak, it is a reasonable public policy measure for governments to make direct investments and shore the banks' balance sheets up if taxpayers are being compensated - and they are.

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