If you are new to this blog, you are invited to read first “The Largest Heist in History” which was accepted as evidence and published by the British Parliament, House of Commons, Treasury Committee.

"It is typically characterised by strong, compelling, logic. I loosely use the term 'pyramid selling' to describe the activities of the City but you explain in crystal clear terms why this is so." commented Dr Vincent Cable MP to the author.

This blog demonstrates that:

- the financial system was turned into a pyramid scheme in a technical, legal sense (not just proverbial);

- the current crisis was easily predictable (without any benefit of hindsight) by any competent financier, i.e. with rudimentary knowledge of mathematics, hence avoidable.

It is up to readers to draw their own conclusions. Whether this crisis is a result of a conspiracy to defraud taxpayers, or a massive negligence, or it is just a misfortune, or maybe a Swedish count, Axel Oxenstierna, was right when he said to his son in the 17th century: "Do you not know, my son, with how little wisdom the world is governed?".

Saturday, 8 August 2009

Why banks are still not lending?

Mr Robert Peston, a BBC Financial Correspondent, disclosed on his blog information on Royal Bank of Scotland and Lloyds. Assuming other banks follow the same or, more-less, similar practice (and it is very likely) this appears to explain, why banks are not lending on the level that normally would be expected from such institutions. He wrote:

"Take Royal Bank of Scotland. Today, its chief executive has set a target to reduce its ratio of loans to deposits from 156% to around 100% by 2013. (…) And there's a similar story for Lloyds. In the six months from 31 December to 30 June, its ratio of loans to customer deposits has fallen from 166% to 152%, as it has simultaneously increased deposits by £20bn and reduced loans and advances by £25bn."

This information confirms that both RBS and Lloyds were lending with loan to deposit ratio above 100% reaching the current level of loans to deposits. Mr Peston does not write what is the actual level of loans (and also deposits) in monetary terms. It is this factor, that resulted in overblown banks’ balance sheets, which led to liquidity crisis. This is why, to prevent a collapse, the government had to provide fresh liquidity (in form of cash injection, guarantees and now “quantitatively eased” cash) to increase banks’ reserves to secure overblown balance sheets.

Although it is not clear from Mr Peston reporting, there is an indication that these two banks (and possibly many others) could still be lending with loan to deposit ratio above 100%. And in case of RBS the ultimate target is actually 100%. This indication comes from slow lending, very little liquidity provided onto the market by the commercial banks.

This situation appears to be (and it definitely has been) perverse. If banks lend with loan to deposit ratio above 100% their profit margin model is as follows:

L*I(L) – D*I(D) > 0

(where L is value of loans, D is value of deposits, I(L) is interest paid in by customers on loans, I(D) is interest paid out by banks on deposits)


(where LD is the current ratio of loans to deposits)


D*LD*I(L) – D*I(D) > 0

LD*I(L) – I(D) > 0

As LD is above 100%, this model allows what one would consider as impossible: pay higher interest on deposits than to collect on loans. This is easy money for a bank. This explains why for years of the credit boom banks were able to offer very low (quite often 0%) interest rates on loans and still pay quite attractive rates on deposits. This completely distorted competition on the market as well as pay packages of the bankers.

But such bonanza could not last forever. As described in the seminal article of this blog "The largest heist in history" this is a pyramid model, called “depleting-reserves banking” as this results in reserves depletion, (depleting reserves at [loan-to-deposit ratio] – 100% at every cycle of deposit – loan cycle). Having nearly gone bankrupt, the banks are now very weary not to deplete the reserves (provided by the government actions) too quickly. Hence they are lending very slowly. The deposit - loan cycle pace is very slow. This slows down the process of reserves depletion but unfortunately is also severely restricts liquidity on the market, which is based on circulating money in the economy. Banks have a perverse incentive to hold on to cash and limit lending.

If banks were lending with loan to deposit ratio below 100% (as they traditionally had been doing for centuries), the same formula:

LD*I(L) – I(D) > 0

would still apply.

However, as this time LD is below 100%, the interest on loans must be higher than on deposits in order for banks to have a positive profit margin, to make money. Therefore banks would find it harder to make profit, i.e. they would have to be more costs efficient in their operations. This would mean that less money would be available for big bonuses. However banks would be able to circulate money in the economy as fast as they could as at every deposit – loan cycle they would have generated reserves at 100% - [loan-to-deposit ratio] level.

The government must therefore examine whether banks are still lending with loan to deposit ratio above 100%. The above shows that such practice is criminal as it is a result of a pyramid scheme structure. If they still do (as the signs do indicate) the government must ban it. It creates a perverse situation of further depletion of reserves, effectively slows deposit – loan cycle and creates an inefficient competition environment for the financial industry combined with over-inflated remuneration packages, which effectively come from the loot: reserves depletion. Most likely it is a systemic problem: so all the industry should be examined, not particular institutions. Let us face the real problem: the business model that the financial industry developed in the last few decades is a parasite on a real economy.

The above is on top of other concerns highlighted in the articles: "Is another loot going on now?" and "How to make money?"


  1. I can not understand why you have differentiate between Banks and Government treasury. Government deficit financing is like Banks giving loans without base capital.

  2. Thanks for your comments: the difference between Banks and Government treasury is massive. "Government deficit financing is like Banks giving loans without base capital." – this is correct in principle, but not in practice (but with a limit to it).

    If banks run out of money (like they did last autumn) their ability to raise capital is very restricted, i.e. banks can go bust. On the other side governments can underwrite any spending with the wealth of the entire countries (and for generations ahead). That is why with AAA rated countries their ability to raise additional funds (capital, etc) was regarded for practical reasonable reasons as limitless. That’s why governments could rescue banks (whilst banks could not rescue themselves). Governments underwrote the entire banking system with national wealth (and for generations ahead). For AAA rated countries, governments' guarantees are deemed as good as cash. Thus far it seemed to have worked, although it did not deliver a healthy recovery yet.

    It is possible, indeed it is quite likely, that this crisis will test several governments in terms of ability to raise funds (and their credibility).

    NB. You may be interested in reading “A US way out?” article: http://gregpytel.blogspot.com/2009/04/us-way-out.html

    Best regards

    Greg Pytel

  3. I recently came across your blog and have been reading along. I thought I would leave my first comment. I don't know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.