Who should be tightening their belts - banks.

After the global financial crisis there has been much talk of the need to tighten our belts. Most is hypocritical as it is used to justify cutting other peoples income or benefits. It is also misguided because the paradox of thrift tells us that it if we all cut spending everyone's income decreases by the same amount and we all just become poorer as a result. However there is one group of people who definitively should be tightening their belts, namely bankers. The current financial mess is the result of banks becoming insolvent because of excessive, risky lending. Banks, unlike any other business entities, operate with incredibly low levels of equity*, at around 2-3%. This means that a tiny (i.e. 4%) drop in the value of their assets (e.g. a small number of defaults on mortgages) can make them insolvent, at which stage taxpayers usually have to step in to rescue them to avert contagion, imposing a large costs on the rest of the economy.

It makes no sense at all for such systemically important parts of the economy to operate with far thinner equity cushions than other businesses. If anything they should be higher. So you would have hoped that bankers would be required to increase their equity cushion to a more reasonable thickness such as 20-30% of assets, which is what most businesses and individuals use. They can easily do this by simply retaining their considerable profits. But banks have strenuously resisted such an adjustment and instead banks executives have distributed these profits out to themselves in the form of very high salaries and obscene bonuses. As a result their equity cushions are still very thin and they remain at higher risk of collapse, which will require an expensive rescue. This is completely insane. How can we allow them to get away with such extraordinarily antisocial behaviour so soon after they almost destroyed our economies?

[*equity is difference between your debts and your assets, usually expressed as percentage of assets. Assets of £100 and debts of £97 mean equity of £3 or 3%. Equity allows businesses to absorb losses without becoming insolvent, acting as a cushion. The thicker they are the more robust the businesses are to shocks like a customer defaulting on it debts]