Are banks necessary?

"Do capitalist societies need banks?" veteran bank analyst Richard X. Bove asks today in a report to clients of his firm, Rochdale Securities LLC.

As I've noted, big, solvent companies at the moment have little trouble raising funds: they sell bonds at historically attractive rates. But small businesses are having a tough time getting money from banks, which are still under extreme pressure from bad loans, declining property values and increased regulation.

Bove says the banking system faces attacks from right and left:

US Rep. Ron Paul, R-Tx, who replaces Barney Frank as head of the House banking committee,  wants to "End the Fed." The Federal Reserve currently "creates" money by buying US Government debt, as Bove notes. Gold now backs less than 10% of oru dollars. If the Fed gets clipped, "where will the money come from? How will the economy get access to credit?" The financial system as it exists will grow slowly, if at all.

Meanwhile the Dodd-Frank reform bill is forcing banks to designate more reserves against possible losses, charge lower fees, and submit to more regulation. That, too, slows lending.

Either way, "the funds normally provided by the banking system may now have to be accessed through the credit markets," by selling bonds. Investment banks and investors (like pension funds) who control the bond trade will "move exisitng funds to sectors that offer the higherst risk-adjusted returns. This tends to be older and more established cmopanies. Does this drive up the cost of funding for everyone?"

While the US dithers between hot and cold cures, European and especially Chinese and Asian banks "will not be inhibited" by US rules, Bove concludes. They'll keep financing "major capital projects" in other countries, and small ones too. "Does this help the United States economy?"