Measuring bang-for-buck is crucial in cost-benefit analysis of government programmes. We need a reasonable bang-for-buck metric to evaluate the cost-benefit of NAMA and alternatives.
As I have argued in an earlier post, the main objective of NAMA is to increase risky lending to Irish businesses. This leads to an obvious cost-benefit metric for NAMA and alternatives: Euros of additional commercial lending by banks generated per Euro of risk capital provided to the banks by the government. I will call this the risk capital bank lending multiplier.
How big is the risk capital bank lending multiplier of the NAMA plan? It should be substantially higher than the banks’ normal equity leverage ratio to justify government intervention. If the multiplier is less than 10, then some alternative, perhaps do-nothing as a cautiously sensible choice, is preferable.
The multiplier is not a comprehensive measure since the type of induced lending also matters. If an injection of risk capital can induce the banks to change the composition of their loan books, with more high-risk entrepreneurial loans and fewer safety-first mortgages, this could be employment and growth-enhancing even if total loans do not increase. The multiplier does not capture this but it is still a useful, partial measure of policy effectiveness.
Risk capital is not identical to equity capital, although providing new equity capital is one method of risk capital provision. When NAMA purchases risky loans from banks for cash, it is injecting risk capital into the banks. The government’s blanket guarantee on bank borrowing is also a type of risk capital injection into the banking system.
Different types of risk capital can be standardized by scaling them using a reward-to-variability ratio. So if NAMA purchases a portfolio of risky loans with annual volatility of 20 billion Euros and we assume an equity risk-to-variability ratio of 0.20 than this is equivalent to 4 billion Euros of equity capital. This is only a rough guide since volatility is not a uniformly reliable measure of risk.
NAMA, NTMA acting on behalf of NAMA, or a government agency should provide a credible case that the risk capital bank lending multiplier for the NAMA programme is large enough to justify the trouble and expense.
