Bank Regulator! How dare you distort the markets this way! Look at what you’ve done! And you’re not even sorry. Shame on you!
Arrogant regulatory busybodies thought they could stop bank crisis forever, by setting capital requirements for banks based on perceived risk. The higher the perceived risk, the higher the capital needed to be, and the lower the perceived risk, the lower the capital.
And, in doing so, the regulators completely ignored the fact that banks and markets already clear for risk by means of interest rates, amounts exposed and contractual terms. And as a result banks could earn much higher returns on equity when financing what was officially perceived as “not-risky” than when financing what was officially perceived as “risky”, like our small unrated businesses and entrepreneurs.
And we are not talking about minor differences. Basel II required banks to hold 8 percent in capital when lending to small businesses, which meant banks could leverage 12.5 to 1, but allowed banks to hold only 1.6 percent in equity against a private asset rated AAA, (or a loan to Greece) allowing the banks to leverage a mindboggling 62.5 to 1. Five times less bank equity!
And the result is that these regulations added immense regulatory bias in favor of what is perceived as not risky, on top of the natural bias that already existed in their favor, and, consequentially, added immense regulatory bias against what is perceived as “risky”, on top of the natural bias that already existed against the risky.
And all this the regulators did without ever bothering to ask themselves the question of…what is the purpose of the banks?
And all this the regulators did without ever bothering to reflect on the fact that all bank crises ever have occurred because of excessive exposures to what was erroneously perceived ex ante as “not risky” and never because of excessive exposures to what was ex-ante correctly perceived as risky.
And as a consequence here we find us mired in a deep crisis with obese bank exposures to what was ex-ante perceived as “not risky” and anorexic banks exposures to what was considered “risky”.
And, of course, by maintaining the same fundamental capital requirement discrimination based on ex-ante perceived risk, there is no way we can work ourselves out of a crisis, in which our economies are turning flabbier and flabbier by the second.
Regulators, don’t you know that nations develop by generously allowing for daring opportunities, and fail and fall when turning stingy and coward?
What would the US Supreme Court opine about bank regulations which discriminate against The Risky and favor The Infallible?
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