December 21, 2007
No more easy cash: banks must take their losses
By Charles Wyplosz
The combined central bank injection of liquidity last week was impressive. Still, more than five months after the interbank market froze, banks’ thirst for cash seems unquenchable. The central banks have done everything they can to keep financial markets orderly. They took the risk of feeding the moral hazard beast and what did they achieve? So far they have avoided the much-feared “Big Crunch”, but the end of the tunnel is not yet in sight. The time has come to ask the harder question: do commercial banks get it?
The big commercial banks hold mountains of cash, probably because they still have mountains of sickly off-balance-sheet liabilities that they are unwilling to acknowledge. Or it is because they fear that other banks are in that position and that this could trigger the Big Crunch. Or they just think that other banks think that way. Prudence is a much-needed virtue in banking, the more so because it has been forgotten in recent years.
But the further cash injection will not provide the permanent solution: the return of interbank lending. For that to happen, banks need to be reassured about each other. Recapitalisation is the only solution. Three big banks – Citibank, UBS and Morgan Stanley – have shown the way in recent days. They remind us that large losses must be financed by fresh share issuance. It matters little who provides the cash. We should not let concerns about sovereign wealth funds stand in the way of a permanent solution.
The remainder of this column can be read here. Debate from our panel of economists appears below.
