35 years: Securitisation
Rob provides a background to the current banking system by discussing how money is created, and how it impacts ROE and bank regulation.
Rob provides a background to the current banking system by discussing how money is created, and how it impacts ROE and bank regulation.
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14 mins 3 secs
Under Basel I, securitisation not only provided banks with plentiful cheap funding to lend, but also allowed banks to reduce the capital they required for the assets they sold to securitisation companies. This led to a spiral of increasing leverage in the banking and investor or shadow banking systems.
Key learning objectives:
Define money, and identify where it comes from
Understand how the crisis impact Northern Rock
Understand how bank regulation impacts ROE and leverage
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A couple of months later, the UK had its first bank run in over 100 years. Individual savers queued in the streets waiting to withdraw their savings from the Northern Rock Bank. The Rock was one of the biggest providers of residential mortgages in the year up to the end of June 2007. They lent nearly £19bn more than its borrowers had repaid. Its mortgage assets expanded by nearly 28%.
The Rock used securitisation to raise much of the money it needed to lend to house buyers, but the money had gone. It couldn’t raise any more money, and it looked like it couldn’t meet its commitments to lend or even repay the deposits people were queuing to withdraw. The Treasury and the Bank of England had to lend the Rock £27bn, and they wanted it back quickly.
Money, to be precise, commercial money, the practical money we all need to use, is created by banks and not by central banks. When banks lend, they create assets and liabilities on their balance sheets - they create deposit accounts which they owe to their customers. Their customers can spend the money in those deposit accounts.
Some banks lend more than their customers want to keep deposits with them. Others find they can’t lend money out as fast as customers lend them the deposit money. The latter have to lend to the former to make the system balance (plumbing).
Basel I rules and its interaction with securitisation provided banks with a major opportunity to create more money. The Basel I rules were revised into Basel II before the crisis, but its implementation was not yet complete. These revisions meant each pound of equity could support more and more lending, leading to more money creation.
Basel I and securitisation, and then Basel II made it straightforward to increase leverage - simply lend more money to create more money. The UK banking system created new money equal to 10% of GDP, £120bn, and lent it all to homeowners.
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