Did really the Basel Committee dare to ignore the markets completely? 100%?

Since 1997 I have been speaking out against the regulatory paradigm of capital requirements for banks based on ex-ante perceived risks applied by the Basel Committee and I have never really been able to figure out what went on in the minds of the regulators to come up with such an idea that, though sounding so logical, more-risk-more-capital less-risk-less-capital, is so utterly faulty and counterfactual, since bank crisis never ever occur form excessive investments in what ex-ante is perceived as risky- when in fact it is just the opposite.

My main suspicion derived from the fact that I have never seen the Basel Committee define a purpose for the banks, and, not doing that, led of course to the wrong regulations.

But lately I am starting to get an inkling that an even more astonishing possibility lies behind it all.

Could it really be that regulators completely ignored what “the riskier”, when paying higher interest rates than for instance those rated triple-A, contributed to bank equity?

Currently a bank lending to a triple-A rated company needs 1.6 percent of capital which allows for a 62.5 to 1 leverage, but when lending to an unrated small business it needs 8 percent of capital and is therefore limited to a 12.5 to 1 leverage.

Let us assume that the margin before credit losses on a loan to a triple-A rated company is .4% and that of a loan to an unrated entrepreneur, 4%. In that case triple-A rated companies provide the banks of a before credit losses return on equity of 25 percent (.4*62.5) while the loans to an unrated small business would result in before credit losses return on equity of 50 percent.

But what if both types of loans could be made with a 62.5 to 1 leverage? Then the unrated small businesses would provide a before credit losses return on equity of 250 percent (4*62.5) in which case we would ask... why regulators feel they are safer with banks lending to triple-A rated clients for a 25 percent margin before credit losses than lending to small unrated businesses that provide a 250 percent margin before credit losses? Do regulators really believe that the bankers are so bad at analyzing credits to small businesses so they are better of just following the ratings of the credit rating agencies?

If both types of loans were made with a 14.5 to 1 leverage? Then the triple-A rated clients would provide the banks with only 5 percent before credit losses return on equity (.4*12.5) and of course then the banker would have a better incentive to try to do a good job lending to small businesses as they are supposed to do.

Please read from The Basel Committee on Banking Supervision the document “An Explanatory Note on the Basel II IRB Risk-Weight Functions", July 2005.

In it we find “Interest rates, including risk premia, charged on credit exposures may absorb some components of unexpected losses, but the market will not support prices sufficient to cover all unexpected losses.”

That leads us to suspect that the Basel Committee completely ignored all the differences in interest rates that the market charges based on perceived risk… something like saying “the market is absolutely and totally useless and so we need to impose our own risk-weights, independently of what it does". Is this what they understand as de-regulation? What hubris! Help!