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It's called fractional reserve lending... and it works until it doesn't. As long as your "divedsified" losses are less than (~10% of loans) your reserve collate
by kurthr 8y ago
It's called fractional reserve lending... and it works until it doesn't. As long as your "divedsified" losses are less than (~10% of loans) your reserve collateral (actual Treasuries and Rentable real estate) which generate cash or can be used to pay taxes... then you're solvent. If not then assume the Fed will bail you out... they did last time.
Meanwhile, you can lever your "low risk" loan income 10x so that 1-3% marginal yield looks like 10-30% profit. Hard to give up that crack pipe!
- neffy 8y agoSorry to be the bearer of bad news.. The fault tolerance of banks using FRB, is approximately 1% of loan capital per year. Any more than that, and they are driven into regulatory incompliance - which then has monetary significance. Reserves don't actually play a roll in loss management, bad loans have to be written off against loss provisions and/or profits - liability/equity accounts. Basel 3 has put mandatory limits on how much loss provisions/capital has to be held, but it hasn't solved the fundamental problem with the interaction with the money supply.