Saturday, July 7, 2012

The complaint I presented to the Consumer Financial Protection Bureau CFPB



I refer to the Equal Credit Opportunity Act (Regulation B) in order to present the following complaint: 


Banks consider credit risk information, like that contained in credit ratings, when setting interest rates, amount of loans and other contractual terms… this causes a natural market based discrimination of those perceived as risky. We all know well Mark Twain’s description of a banker: that as the one who lends you the umbrella when the sun shines, and wants it back, urgently, when it looks like it is going to rain. 

But when bank regulators use the same credit risk information, in order to also determine the capital requirements for the banks, then they produce artificial regulatory discrimination in favor (a subsidy) of those already favored by being perceived as not risky, and against (a tax) those already being disfavored by being perceived as risky. And I argue that this regulatory discrimination is contrary to the spirit of the Equal Opportunity for Credit. 

The discrimination occurs in the following way. If a bank is allowed to have less capital when lending to the not risky that signifies he can leverage its equity more and therefore obtain larger returns on equity when lending to the “not-risky”. If a bank is forced to have more capital when lending to the risky that signifies it can leverage less its equity and therefore obtains lesser returns on equity when lending to those perceived as “risky”. To make up for this regulation and present the banks with the same opportunity of returns on their equity, the “risky” need to pay an additional interest rate, and this additional is quite substantial. 

The capital requirement regulations are explained in terms of making the banks safer, but that is not the case, in fact it makes the banks more unsafe. There has never ever been a major bank crisis that has resulted from excessive exposures to what was perceived as risky, think of Mark Twain’s banker, they have all resulted from excessive exposures to what was ex ante considered not risky, but, ex post, turn out to be very risky. And in that respect it allows for excessive leverage buildup precisely in those areas that contain the greatest risk and consequences of bad surprises, namely the lending to what is perceived as “not-risky”. 

Let me just end by commenting on the great contradiction that the discrimination of those perceived as risky, like the small businesses and entrepreneurs, really signifies in “a land of the brave”. 

Please help stop that odious discrimination.