As banks continue to report strong (although slowing) earnings, a large portion of the “growth” has come thanks to an accounting maneuver that reduces reserves and takes that notional capital back into revenue. The reality is that the current fractional banking system is woefully under-capitalized all over the world. Much higher reserves are needed to restore stability to the system and push risk back on to bankers and their investors and off of the public–customers and taxpayers.
“SitkaPacific Capital Management’s Mike Shedlock, who is also the author of the Global Economic Analysis blog, says the Cyprus fiasco is an example of what can happen in a banking system that really can’t guarantee everything it’s promised. He argues these are issues that exist in the U.S. banking system too.
“The whole idea of insurance when you have lent out 50x more money than you have, is fraudulent,” he says.
Shedlock points to New Zealand, which does not promise to insure depositors, as a better system.
Depositors may be forced to figure out if the banks they put their money in are solvent. Shedlock says the current system creates “moral hazard.”