How to Create Zombie Banks

New Tactics Boost Bank Profits – WSJ.com.

This article states that

“But some analysts say that by using the maneuver, banks are killing off avenues of low-cost, long-term funding that are needed to fund loans and operations. That, in turn, could make banks more dependent on the low-cost funding lifeline from the European Central Bank.”

This is the downside to Central Bank intervention. Since they will not be allowed to fail, banks know that they can rely on cheap funding from the central banks forever. Therefore, they no longer need to raise private capital. The banks have become permanently dependent on cheap capital provided by the taxpayers.

If you don’t allow banks to fail, then you are allowing your banking system to fail instead. Unproductive banks make less money so investors move on to the productive banks. Eventually, the unproductive banks lose all of their investors causing a bank failure. By removing the unproductive banks from the picture, the whole system becomes more productive on average resulting in greater gains for the entire economy.

When banks are not allowed to fail, the whole banking industry becomes more unproductive subtracting money from the economy. This is exactly what has happened in Japan since 1990, and it is happening here and in Europe as I write.

 

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