Some Bangladeshi banks are having problems in the interbank market. In a way, we can say this is the same problem the European and American banks had in 2008 and 2009. Which was, as we all remember, a big, big, problem. In another way, we can say that this is a terribly minor problem. As the Bangladesh Bank, the central bank, is dealing with this correctly.
The central thing we have to understand here is that the books of every bank must balance at the end of every day. Loans out to people must be exactly balanced by deposits in from customers plus the capital of the bank. But, obviously, some days Sonali will lend out a little more than they accepted in deposits, while Bengal Commercial has gained more deposits than they gave in new loans. Ok, that's easy enough, Bengal lends some money to Sonali and everyone's books balance.
This is called the interbank market -- sometimes the “overnight” market. For at the beginning of the next working day Sonali sends that loan back to Bengal. And then everyone works away until that evening when they measure those loans and deposits again.
There is nothing wrong with this and absolutely no implication that a bank that borrows overnight has done anything wrong or has any problems. It’s just part of the normal ebb and flow of how banking works.
What happened in 2008 in London, New York, and elsewhere was that this system started to break down. Because every bank was worried that every other bank might go bankrupt or bust. So, they weren't willing to lend during the overnight market. But that means that the banks that could not borrow to balance their books. And a bank with unbalanced books is bust anyway.
This is what happened to a friend of mine. If other banks would lend to his bank then he'd be fine. But they wouldn't -- so his bank was bust.
We've known the solution to this since the 1850s -- yes, the 1850s. The central bank should lend to these banks instead. Obviously, it should check that they are ok, and only have this short term problem first. But the central bank can just print more money, however much is needed, so that all the books of all the banks balance.
But that then has its own problem. If the central bank then prints money to solve the banking problem then that means that the amount of money in the economy is rising. We therefore get inflation. Sometimes this is still what we do. But at other times we're already worried about money and inflation. So, we don't want to do that.
They're providing liquidity to banks in trouble by assuming the risk of other banks lending to them
But think back to the problem. The banking system as a whole has as many deposits as it does loans. So the system as a whole will be in balance. It's just that some banks have a surplus, some a deficit, of deposits. So, if we can move that surplus then we've solved the problem. The banks won’t do this on their own, through that interbank market, because they're worried. The central bank doesn't want to create new money because of the likely inflation.
The solution here is that the central bank takes the risk of banks lending to each other. Then the surplus does move to where there's a deficit, but that risk stays with the central bank. We've solved our problem without bankruptcies, without inflation.
This is also what the Bangladesh Bank, the central bank, is doing. So, good on them. Good policy and at least so far done well. The other central banks around the world have all done something similar in effect even if the mechanisms have often been different -- everyone learned from 2008.
Now, this isn't the end of the problem in banking of course. It is possible that some of those banks have lent too much to the wrong people. That's the sort of thing that does happen in an unfree economy, loans get given out because politics is not good business. But this is also something that can, and will be, solved over time. It's not a problem that needs to be solved today. It's also not a reason for people to rush to take their cash out of the bank.
That is, the Bangladesh Bank has sensibly solved the immediate problem. They're providing liquidity to banks in trouble by assuming the risk of other banks lending to them. This does indeed solve that immediate problem.
We all spend enough of our time grumbling about what the government gets wrong. It's right that we should, at least occasionally, note what they're getting right. The Bangladeshi banking system may well not be perfect and there are some banks in it that are going to have to be worked upon. But as long as the central bank is assuming the risk of providing liquidity then the system as a whole is safe.
So, well done.
Tim Worstall is a senior fellow at the Adam Smith Institute in London.
