Thought about banks and safety

During the 5 years from 1987-91, a total of 1,901 US banks and savings & loan institutions either failed or required financial assistance from the government or more than 1 per day. Through the first 10 months of 2011 (i.e., YTD through 10/31/11), 85 banks had failed in the USA or 1 every 3½ days (source: FDIC).

We all know money in bank accounts is safe and secure and banks are a great place to keep some of the funds that should not be exposed to risk.

Banks claim they need a real return on equity of 15 per cent, to be able to get funds from investors. What they are telling us in fact is that they are running a risky business. 

The question is: can we afford to have financial institutions that are so large and so essential and yet run big risks?                                  The answer is probably: no.

We should make banks safe! It really should not hurt.

If banks respond that by making them less risky, especially with higher equity requirements, they could not be funded at all, it would mean that there is a lot of skepticism among investors about the quality of bank assets.

There are two reasons why banks might earn 15 per cent returns on equity other than risky, highly leveraged balance sheets. One is that banks can earn monopoly profits and the other is that they are subsidized, primarily by the taxpayers who provide insurance against catastrophic risk, especially for the bank creditors. The two - monopoly and subsidy are related.

While we need banks to be able to operate freely and have less government intervention, banks should be kept somewhat more accountable and have some safe guards against undue risk taking.
This information is not intended as and should not be construed as investment, tax or legal advice.