The equity of 100% equity financed banks would be incredibly safe. 1/10 the volatility of current banks. It would be an attractive asset. The private sector really does not have to hold any more risk or provide any more money to an equity financed banking system. We just slice the pizza differently. If issuing equity is hard, banks can just retain profits for a decade or so.
Or, better, our regulators could leave the banks alone and allow on on-ramp. Start a new “bank” with 50% or more equity? Sure, you’re exempt from all regulation.
And, in case you forgot, we live in the era of minuscule interest rates — negative in parts of the world; and sky high equity valuations. All the macroeconomic prognosticators are still bemoaning a “savings glut.” A scarcity of investment capital, needing some sort of fine pizza slicing to make sure just the right person gets the mushroom and the right person gets the pepperoni does not seem the key to growth right now.
He chose the excellent title “Tyler: Equity financed banking is possible!” Do read the whole thing, it is a very good and useful post.
I would add a few points in response. First, I think equity banking would have to be very tightly regulated to remain as such, more than the status quo. There always would be incentives to take on more off-balance sheet risk for higher returns. Second, a much bigger commercial credit sector would have its own maturity mismatch problems. It might be better than the status quo, but it too likely would end up with a lot of bad regulation, or maybe it would become a no-less-dangerous form of shadow banking. In general, I don’t think our current form of government can precommit to “no regulation.” Third, money market funds work pretty hard to maintain fixed nominal value for their depositors. Admittedly this is a theoretical puzzle, but that we don’t understand the prevalence of debt at various levels (and that prevalence is all the stronger outside the U.S.) does not lead me to think we can alter it as we might wish. That the theory of capital structure is so weak I do not take to mean that capital structure is so remarkably flexible. Finally, I don’t think the savings glut is all that relevant for SMEs, and traditional banks still seem to be more efficient at matching borrowing and lending at the local level. Again, this is a phenomenon we do not understand very well (Fama 1985), but I am not so confident we can undo it. I also don’t think the savings glut will last much longer, given Asian demographics.
That all said, I would gladly experiment more with equity banking and indeed have written as such in the past. I am less sure it will do away with our current regulatory dilemmas. I don’t think it is easy to get around having a part of the economy which is both systemically risky, and also debt-intertangled, as the evolution of shadow banking over the last fifteen years seems to indicate.