Why banks cannot fail
After talking to friends at Lehman and one of the two Iceland-owned British banks allowed to fail, I am inclined to think that the main reason why depositors in UK banks can expect the Government to keep them safe from loss is not the impact on depositors so much as the impact on a bank’s corporate customers of a commercial bank going into administration.
This is chaotic and potentially disastrous for cash flows. It will not be long before we discover how many businesses fail as a direct result of the administration of Lehman, Kaupthing Singer & Friedlander and Heritable. If these unmanageable impacts on business customers’ cash flows were replicated by a larger bank, in an economy already buffeted by competitive deleveraging, it would trigger an unstoppable slump. It is not the banking system we have to worry about, as this can be supported by printing sterling, but the economy.