Monday, 14 November 2011

Securities lending is similar in form to fractional reserve banking

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2 comments:

  1. Lawrence J. Kramer18 July 2013 at 04:16

    I had this thought, too, so I Googled it, and was excited to find this blog "post." Now that I've "read" it, I'm not quite so excited. Any chance you could elaborate or cite someone who has?

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  2. Geolibertarian18 July 2013 at 13:54

    There are many ways to think about money and one of them is that each unit of currency represents a piece of stock in the issuing nation. Using this model it is not too difficult to see that lending out money at interest is a pretty close analogue to what happens with securities lending... simply transposing the money with stock.


    But I think a more interesting parallel arises when we think about what happens when the lending institution has problems with liquidity in the underlying asset...

    I was thinking quite a bit about fractional reserve banking and what happens when all of the customers want their money back. I remember being told some time ago about how securities lending works not thinking too much about it at the time. Then I realised that the securities lending institution would get into quite a bit of trouble if all of the underlying asset-holders suddenly want their portfolio returned... perhaps they are on the other side of an insurance portfolio and there is an insurance event. Then all of the loaned securities will need to be returned and this would be directly analogous to a bank run in fractional reserve banking where the important assets are 'out there' in the market and cannot be returned immediately. Those who practice securities lending seek to profit from the depth of their holdings in stock just as a bank profits from holding so much cash... both can run into problems if there is a liquidity crisis. I guess my point is that neither is immune from this risk be they a securities lender or a bank.

    We might not hear so much about the risks involved with securities lending because the scale is much smaller and perhaps because not so many people are concerned with their pension or insurance fund falling over as they would be with their bank failing.


    Hope this makes sense

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