Now that governments around the world have declared they won’t let banks fail, at least certain banks that is, credit should start flowing between these banks naturally at national and international levels. But the credit is not flowing yet and this is due to lack of confidence between the banks.
This lack of confidence is due to lack of timely and accurate financial information (aka transparency) relating to the quality of the balance sheets of banks. Bank A will not do business with Bank B because of fear that B may be unable to honor its obligations due to toxic assets (aka bad loans or derivative positions) or go out of business even though Bank B’s government has bailed it out before.
But if governments (central bank’s, treasury’s, etc) are already acting as an insurer of banks through bailouts what is needed is to go one step further. This need not cost more per se. That step is moving bank to bank lending and borrowing onto a central market place where all transactions are guaranteed by a clearing house. In financial speak, move bilateral over-the-counter interbank trading onto an exchange with a central clearing house and clearing members.
Sure, there would be implementation issues like who would manage the exchange (While Intrade is happy to help ;-) perhaps the G20 could establish), who would be the clearing members and what banks would get trading rights. Also the thorny problems like would or should Ireland be able to join with our current precarious (albeit exaggerated) position? It should also be a pre-requisite for any bank to get approval of their guarantor Government before they can trade on the interbank platform to provide the very best financial information about its assets and liabilities.
Access to the market would create massive incentives for governments and banks to “come clean”. The incentives are access to credit and comfort when giving credit. If Japanese banks had such an incentive in the 90’s would they have recognized their debts earlier and would this have shortened their lost decade?
So, if what is needed is more transparency and trust then use an exchange with a clearing house. They work elsewhere. They have a big role to play here now we think.
What do you think?