Thursday, September 20, 2012

Educating Martin Wolf (and others in dire need of it): Stupid Bank Regulations 101

When banks are allowed to hold less capital against assets perceived ex-ante as “not risky” the regulators are effectively discriminating against banks holding assets ex-ante perceived as “risky”, like loans to small businesses or entrepreneurs. 

And that amounts to a distortion of the market. The direct effects of that distortion is that those perceived as not risky will have an ampler and cheaper access to bank credit than what would have been the case without these regulations, and those perceived as “risky”, will have a scarcer and more expensive access to bank credit that would have been the case without these regulations.

In other words, it signifies a regulatory subsidy to those already benefitted by the market and banks from being perceived as “not risky”, and a regulatory tax on those already being taxed by the market and banks because they are perceived as "risky".

In other words we´ve got ourselves a much ignored class-war carried out under the cover of bank regulations by the "not risky" against the "risky".

And that discrimination against what is perceived as risky, must of course negatively impact the economy and the creation of jobs, which both thrive precisely based on the risk-taking. 

And all for no good purpose at all, because never ever has a major bank crisis resulted from excessive exposures to what was ex ante perceived as risky. 

And all that regulatory nonsense, or even worse than nonsense, is a direct result of not specifying clearly what the purpose of our banks is. Surely it cannot be to survive in an economy where everything else fails.

And, if regulators absolutely must interfere, because it is in their nature, then why don´t they do it with a purpose, and for instance set the capital requirements for banks based on potential-for-jobs-for-youth ratings?

And, if regulators absolutely must interfere, and must to do so based on perceived risks then why not do so based on how bankers react to perceived risk. Although in that case it would seem that the capital requirements for banks should be higher for any asset perceived as “absolutely not-risky” and lower for any asset perceived as “risky”.

Also as is, no one has any idea of what the real market interest rates are. For instance what would be the UK Treasury rate if banks needed to hold as much capital when lending to the UK Treasury, than when lending to a UK citizen? 

Research assignment (choose one of the two) 

1. Make a regression between the major problem assets during the crisis and the low capital requirements for holding those assets, and then explain what inferences can be drawn from the results. 

2. Investigate who could have authorized bank regulators to award subsidies on access to bank credit to the “not-risky” or tax the access to bank credit of the “risky”. Alternatively you could investigate who could have authorized bank regulators to earn more, by means on higher leverage, when lending to the “not-risky” than when lending to the “risky”.