n conclusion, the model offers a simple explanation of
why the world, for so long after the height of the global
financial crisis, is still mired in slow growth. During a prolonged
and excessive boom bank profits and capital were
materially increased by unrealised FVA profits. These profits
justified the pay-out of liquid assets weakening the
financial system. The additional capital further justified
more debt financed asset expansion. With the crisis bank
management realised that these unrealised capital items
were not permanent. Management was able to postpone
the recognition of FVA losses by using the flexibility inherent
in FVA regulations, but lending was slowed to a point
reflective of ‘‘safe’’ (capital excluding unrealised items)
capital levels. Lending activity will stay subdued until all
of these marked-up items have been worked off banks’ balance
sheets.