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Saturday, August 23, 2014 8:36 PM

Occam's Razor and Bank Lending

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I received an interesting question on bank lending just a bit ago.

The question is in reference to Euro Bond Bubble Guaranteed to Burst where I stated ...

"Would QE by the ECB spur European bank lending? Of course not. Banks do not lend from excess reserves. Banks lend (provided they are not capital impaired), when credit-worthy borrowers want credit and banks perceive risks worth lending."

Reader Kenneth from Stockholm, Sweden writes ...

As a layperson I must say this makes perfect sense, but I have a problem applying Occam's Razor to it. For Occam's Razor to hold, one must assume that the central bank has never talked to a banker, right? Surely the commercial banks must know why they are or aren’t lending? Or is there a hidden pretext for the ZIRP and QE that the central bankers are not telling us? Please don’t say it’s because they’re stupid. A well deserved insult maybe, but that would not hold as an explanation for this.
Not quite. Occam’s Razor suggests the simplest explanation is likely to be the correct one. In this case, central banks clearly want to spur lending. So why aren't banks lending?

Two Possible Reasons Banks Aren't Lending

  1. Banks are capital impaired (even if they deny they are not)
  2. Banks have no credit-worthy borrowers who want loans

I suggest both

That is the simplest explanation that fits the bill, and it also fits in with sound economic theory.

Thus, that is precisely what Occam's Razor would suggest. Whether or not central banks talk to, or understand banks or bank lending is irrelevant.

Moreover, I stick with my assertion that central banks are generally clueless about the state of the economy. This has been proven time and time again.

Thus, it should not at all be surprising to find that central banks are surprised to discover their attempts to spur lending have failed.

For more on the state of lending in the eurozone, including the possibility of capital impairment, please consider Spotlight on European Bank Lending: Capital Impairment to the Forefront.

Mike "Mish" Shedlock

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