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A biblical lesson for today's bankers

Just as Joseph stored food ahead of a drought, banks should build capital for lean times.

By David R. Francis / December 8, 2008

In a talk to European bankers last month, the governor of the Bank of Spain cited a Bible story to illustrate how modern economies might ameliorate the tendency for busts to follow booms in the business cycle.

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Miguel Fernández Ordóñez spoke of Joseph's interpretation of a dream by Egypt's Pharaoh of seven fat and seven lean cows as indicating seven years of "great plenty" followed by seven years of "famine" (Genesis 41). As a result, Joseph was put in charge of the kingdom and set aside a fifth of the harvest in the years of plenty. Thereby, he got Egypt through the following hard times and saved his own family from starvation.

Bringing the biblical idea up to date, Governor Ordóñez suggested financial regulators insist that banks build up their capital at an enhanced rate during prosperous years to put them in better financial shape should a serious slump follow with many boom-time loans turning sour.

Actually, a predecessor of Ordóñez in the 1990s, Governor Luis Angel Roja, did just that. He put into practice a regulatory mechanism termed "dynamic provisioning." This, notes Ordóñez, has reinforced the present stability of the Spanish banking system "and today commands wide recognition."

The biblical story indicates that economies are "unequivocally cyclical," notes Ordóñez. Since Joseph, 4,000 years ago, "perhaps we have made some progress … it seems that the years of plenty are somewhat longer than the lean years," he adds. "But little more than that."

Ordóñez gives credit to William White, a former chief economic adviser to the Bank for International Settlements, a bank based in Basel, Switzerland, owned by the central banks of industrial nations, for promulgating the idea that private banks must specially build up their capital in good times.

Caught on his cellphone in Rome, Mr. White explains that banks have a tendency to ease prudential credit restraints in times of good news, a bustling economy, and rising prices of homes, stocks, and other assets that provide the collateral for even more loans of a shaky nature.

"Rational exuberance turns into irrational exuberance," he says, using a phrase made famous by the former chairman of the Federal Reserve, Alan Greenspan. "Justified optimism turns into unjustified optimism … good times get hyped up."