Archive for December 15th, 2009

Applying Capital Structure basics in Banking

December 15, 2009

Simon Kwan of FRBSF has written a very nice primer on using capital structure lessons for banking. Capital Structure means what should a firm choose debt or equity for its capital?

Capital structure theories seek to explain why businesses choose different mixes of debt and equity to finance their operations. Banking firms represent a special case because of certain unique features in the industry, including a federal safety net and extensive regulation. The financial crisis of the past two years provided another set of special circumstances in which banks needed to raise capital. The preference banks have shown for issuing preferred shares in the private market in favor of government financing can be viewed through the lenses of capital structure theories.

Kwan first discusses capital structure theories which apply to general firms- tradeoff theory, pecking order theory, and free cash flow theory.

He then  says capital structure theories are different for banks

Banks and other depository institutions are specialized businesses whose capital structures are affected by a number of conditions unique to the banking industry, such as government regulation and access to a federal safety net that includes deposit insurance and borrowing through the Federal Reserve discount window. Deposit insurance was created to contain the rapid withdrawals from a bank whose financial condition may be in doubt.

He then discusses the capital structure of banks in this crisis and why banks issued preference shares in this crisis.

Useful stuff.


Copenhagen Climate Round: Unfortunate lessons from Doha Development Round are being repeated

December 15, 2009

Today’s newspapers inform one that the world leaders are now gearing up for the next round of climate change negotiations to be held in Mexico in 2010. The talks at Copenhagen have failed to come to any global consensus with walkouts, tiffs, blaming etc

All these developments take me back to 2001, when the ambitious Doha Development Round was proposed for furthering international trade. The DDR meet at Doha was also followed by a meeting in Cancun, Mexico in 2003. The meeting was a failure and no consensus emerged. Since then we have continued to see one meeting after the other on DDR all leading to the same result – failing to arrive at a consensus. WTO officials keep harping on the need to finish DDR but finds no ears. Each meeting is met by stiff resistance from both developed (who refuse to open up their agri markets) and developing countries (who refuse to open up their industry and services sectors). Each meeting is hyped and ends in a similar fashion. So much resources are wasted. WIth time people seem to have given up on WTO meetings as well and hardly any discussion takes place.

And now I see some crazy similarity with climate changes. There is a lot of hype with absolutely no clarity. Climate change is also more complex than international trade (which is no less complex). You add global discussions to the complexity and you have a perfect recipe for all kinds of hype and chaos. The media gets a lot of fodder for creating all the more hype and then in the end talks fail. People for whom these discussions are, have just no idea of what happened and what is in store for them.

I don’t know what is the solution but this way all important global issues are simply headed to nowhere. The global leaders need to understand that this finally hurts the entire public so some progress is needed. The short-term browny points are too tempting and most just end up doing that trying to impress their electorate. If they can come to some global coordination to bail out banks and pass out fiscal and monetary stimulus why can’t they coordinate on these important issues as well. The question that automatically comes to mind is what made them coordinate fiscal and monetary policies to ease crisis situation?

We keep talking about global economy, global citizen, global this and global that. It is time our leaders also think and act on similar lines.

Literature Survey on Finance & Growth

December 15, 2009

A team of ADB economists (10 in all) have written an exhaustive literature survey on following issues:

  • Whether finance leads to economic development or vice versa?
  • Whether economic growth leads to reduction in poverty?
  • Whether financial development leads to reduction in poverty?


Politics of Financial regulation

December 15, 2009

Paul Krugman has in his NYT article says the politicians have not learnt lessons from the financial regulation.

He begins saying how people just refuse to change their beliefs despite contrary evidence.

When I first began writing for The Times, I was naïve about many things. But my biggest misconception was this: I actually believed that influential people could be moved by evidence, that they would change their views if events completely refuted their beliefs. And to be fair, it does happen now and then. I’ve been highly critical of Alan Greenspan over the years (since long before it was fashionable), but give the former Fed chairman credit: he has admitted that he was wrong about the ability of financial markets to police themselves.


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