Saturday, February 23, 2013

For those in blissful ignorance, this is what the Basel Committee’s Basel II decreed for our banks

We the members of the Basel Committee, as self-appointed guardians of your interests, knowing that banks want to maximize the returns on their equity, and wanting the banks to play it safer and not take risks, hereby ordain: 

Banks will still be allowed to lend to those perceived as “risky”, usually those not rated or those with not so good credit ratings, usually the small and medium sized businesses or entrepreneurs, against 8 percent in capital; meaning that banks are able to leverage their capital with the risk and cost of transaction margins of those exposures, 12.5 times to 1. 

But now, when lending to the safe or the absolutely-safe, the latter including AAA rated securities and so and so sovereigns like Greece, they will only need to hold 4 or 1.6 percent in capital respectively; meaning that banks will now be able to leverage their risk and cost of transaction margins of those exposures, 25 or 62.5 times to 1. (A jolly profitable proposition for playing it safe we would say) 

And finally, in the case of lending to sovereigns considered to be infallible, most often our bosses, at least in a formal sense, then banks need to hold no capital at all, and so there, as far as leverage concerns, the sky is the limit. 

Happy safe and huge bank equity returns!!! 

PS. Of course Basel II led the banks to create the excessive and dangerous large exposures to what was ex-ante considered as absolutely safe but that ex-post turns duo to be Potemkin ratings, and which caused the current crisis. Of course Basel II, and perhaps even more upcoming Basel III, stops the banks from lending to “The Risky”, those we most need to help us to get out of the crisis, and get our youngsters their jobs.