Transcript Anat Admati: What’s wrong with banking (and what to do about it)

00:00 My name is Anat Admati and I’m gonna talk about what’s wrong with banking and what to do about it.

00:12 In order to understand banking you must understand borrowing and leverage. Leverage works the following way; you invest in something with a lot of money that you promise to pay back. And then it’s a wonderful thing because you put a little bit of your own money and if your investments work out then you get a very high percentage of your own investment doubling and tripling and all of that with just a small increase.

00:38 However, there’s a little bit of a problem on the downside. When you have very little equity it gets wiped out very easily and then you might find yourself underwater.

00:54 If you look at some very successful companies, the names of which you know, they don’t bother to borrow very much. No healthy company lives on less than 30 percent equity and that gives them a way to kind of withstand shocks without going under.

01:10 So the question is why are the banks so different from other corporations? The way they fund their loans and investments is from deposits and then they take a huge amount of other debt. Depositors don’t think of it that way but they are lending money to the banks that they expect the bank to pay them back anytime.

01:32 Basically the banks live on almost no equity, so they live very very dangerously. In the sense of an unstable building something happens and they immediately collapse, need bailout, something bad therefore we have a situation in which governments will rush to the rescue and central banks will take all their bad assets out of their hands so that they will not fail.

01:55 By that time their creditors are feeling even better, the depositors are feeling ever more sure. Then, everybody else feels like they are okay, their debts will be paid somehow. And now you get that addiction to borrowing more and more and more getting even worse because now that addiction is fed and enabled by this sort of safety net that we put in by these guarantees.

02:19 What you can see in this picture very clearly is just how incredibly fragile and risky the way banks live is.

02:27 They are now more global and they have more and more ways to take risk and hide risk in all kinds of derivatives markets and other markets and obscure that on their reporting that when we discover just how indebted they are and just how much risk they took it’s often too late.

02:45 The solution is that we need to make sure that the banks don’t live so dangerously because when they live dangerously we are endangered. What we need to do is to make sure that they take more risk with shareholders money rather than with borrowed money. That they use more equity more like other companies and then they’ll be safer for us.

03:07 If we don’t control leverage and indebtedness in banking we just go from boom to bust to crisis again and again.

03:16 The big takeaway is that banking doesn’t regulate itself, that banking must be regulated in order to work for society. Do not believe the spin and narrative that financial crises are just something that we have to live with like a natural disaster.

03:30 So the next time a politician says I need to make my banks competitive globally or any of that, you have to say no that’s not your job. Your job is to make the banking system work for society.