Commercial bank liquidity - the long run trends.

Last week, the FSA were talking tough. In future, things are going to tighten up; no more soft touch regulation, banks are going to have to behave themselves.

The FSA would do well to take a look at just how lack regulation has become over the last forty or so years. The Bank of England track three measures of commercial bank liquidity; the broad ratio, the reserve ratio and the narrow ratio. The definition of these ratios isn't particularly important. All three ratios compare the total assets of the banking sector with what cash and near cash assets the banks are holding.

The basic message is clear enough. Over the last forty years, banks have reduced their liquidity to virtually nothing. Of course, the banks would defend this trend by saying that with financial innovation and increasingly sophisticated markets, it is not necessary for banks to hold so much liquidity these days.

Well, the experience of the last 15 months suggests otherwise.