Monday, March 18, 2013

For Basel IV, what do I propose?

Ex ante perceived risks are already cleared for in the numerator, by means of interest rate (risk-premiums) size of exposure and other terms, and so it is just plain stupid to clear for the same risks in the denominator, with different capital requirements based on risk-weights. That only guarantees a distortion that makes nothing safer, and just causes banks to overdose on perceived risks. 

Therefore risk-weighted capital requirements are to be eliminated completely.

But, if bank regulators absolutely must meddle, in order to satisfy their egos, or show off their expertise, and there are going to be some higher capital requirements for some assets, those should be applied to what is ex ante perceived as “absolutely safe”, since all major bank crises ever, have originated in excessive bank exposures to this category of assets.

And, if bank regulators absolutely must meddle, in order to satisfy their egos, or show off their expertise, and there are going to be some lower capital requirements, to induce some higher returns on bank equity, those should be only accepted in as much as these stimulate the banks to better fulfill a social purpose, like basing it on potential for job creation ratings, or sustainability ratings.

And, in no way shall there be any discrimination that favors any short term financial instrument over a long term one.

And in this respect, the initial Basel IV proposition contains just one line, the following:

“Banks shall hold 8 percent in capital, as defined in Basel III, against all assets.”

The Basel IV capitalization can be reached by allowing each bank to apply its current capital to total assets ratio (including sovereigns), and then let it build up that ratio over a period of some years, with about 0.5 percent per year until reaching said 8 percent level. 

But, since the faster banks reach their final Basel IV capitalization, the better for the real economy, the regulators, accepting their full responsibility for the current extreme low capitalization of banks, should beg for some temporary important tax incentives on all bank capital increases taking place within one year of the Basel IV approval.