"Traditional Banking" Is Indeed Risky
Letter to the Editor

Sir, Clive Crook ("Beware the crisis around the corner," January 4) points out that failed commercial banks "did so mainly through losses in traditional banking." Yes, just as they do each cycle. "Traditional banking," consisting of highly leveraged positions in risky assets, is indeed risky. No one should ever think the contrary.

Mr Crook goes on to say there should be "rules that recognize the credit cycle and change as it proceeds." Right again. The essential new rule of this sort would be that as asset prices accelerate and optimism grows, banking leverage and loan to value ratios must fall, instead of rising, as they typically do.

That the typical financial behavior should thus be made into its opposite is clear in principle. How actually to achieve this, if we exclude illusory faith in regulation, is admittedly murky.

Alex J. Pollock is a resident fellow at AEI.

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