Wednesday, June 11, 2014

State subsidies to banks

States guarantee bank deposits (upto a staggering $250,000) in the US. (In India, the amount guaranteed is piffling in comparison, Rs 100,000 or around $15,500). As a result, banks can borrow money at a lower interest rate than without the government backstop. This amounts to a state subsidy to banks. The value of the subsidy, according to an article in the Economist, is $100 bn in the UK and Japan, $300 bn in the Euro area and a total of $630 bn for the rich world. One obvious way to prune these would be to reduce the value of bank deposits guaranteed. Raising equity capital requirement for banks (and correspondingly reducing debt) would also serve to reduce the subsidy.

One other thought comes to mind. In reporting their profits, banks must reduce the value of the subsidy they get. Executive bonuses must be linked to profits, adjusted for subsidies. That would help rein in executive pay in banking, which is itself a source of systemic risk.

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