Thursday, August 22, 2013

Felix Martin on Money (2) Liquidity Transformation

According to the theory, at least, banks achieve "liquidity transformation"; they transform their liquid, short-term deposit liabilities into illiquid, long-term loans. But the notion of liquidity transform is quite literally a euphemism. Nothing is actually transformed at all. Bank’s liabilities remain short-term and of fixed nominal value, and their assets remain long-term and of uncertain nominal value, and never the twain shall meet. Instead, banks give the impression of achieving a transform by artfully synchronising the payments in out of their balance sheets. No matter how artfully this is done, though, there is always the possibility that people will lose confidence in a bank’s ability to do it (p. 258).
Felix notes that this is a “problem that plagues” every banking system.

He is correct. I have suggest matched loans as the only practicable solution to this problem in Money.

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