The Basel Committee instructs banks to lend as if they were old retirees and not young professionals

Viktor Munkhammar in “Dagens industri”, Stockholm, September 21, wrote “Åldrande befolkning ger centralbankirer gråa hår”.

In it Munkhammar analyses the growing fright about deflation, and most especially what demographic changes can help to produce it… and I agree with most of his arguments.

But, when he writes: “For central banks, this means that the fight against low inflation is unlikely to be over when the consequences of the financial and debt crisis eventually folded.”, then I must intervene to remind him that, in many ways, the financial and debt crisis was already the result of a demographic change… as the Basel Committee for Banking Supervision was hijacked by some retirees’ risk adverse criteria.

What do I mean with that?

We all know that any financial advisor, counseling a young professional on his in investments, would indicate the need for a high degree of risk-taking, like investing in the stock market. And any advisor, similarly counseling an aging professional, soon a retiree, would recommend a much more cautious strategy, which includes for instance highly rated corporate bonds and sovereign debt. And, were the advisor not to follow these simple rules, the possibilities of him losing his license as an investment counsel would be very high.

But the Basel Committee, by means of the pillar of their regulations, the risk weighted capital requirements, have allowed banks to hold much much less capital (equity) against assets perceived ex ante, from a credit risk point of view, to be “absolutely safe”, like “infallible sovereigns”, housing finance and lending to the AAAristocracy, than what banks are required to hold against assets perceived as “risky”; like lending to medium and small businesses, entrepreneurs and start-ups.

And that translates into banks being able to leverage much much more their equity with “The Infallibles” than with “The Risky”; which means banks can earn much higher risk adjusted returns on equity when lending to “The Infallibles” than when lending to “The Risky”; which means banks must and will follow an investments strategy much much more adequate for the old than for the young.

And who pays for all that? The economy, which can therefore only grow obese, as risk taking is the oxygen for any sturdy and healthy economic growth; and as a direct consequence of that all of our young who might not get jobs, because of lack of bank credit to those tough risky risk-takers we need to get going when the going gets tough.

And all for what? For nothing, as this bank crisis was not caused by exposures to what is perceived a risky, bank crisis never are, but because of too much exposure to what was ex ante officially perceived as safe, like AAA rated securities, Greece and real estate in Spain.

Frankly, if regulators absolutely must distort, to show us they are working, why do they not weigh the capital requirements for banks, not based on perceived credit risks which are already cleared for by bankers... but for something with a purpose, like potential-of-job-creation ratings, sustainability-of-planet-earth ratings, or, in the case of sovereigns, ethic and good governance ratings?

And just think how sad it is that a country like Sweden, which became what it is because of daring risk-taking, and where in its churches we hear “God make us daring”, now has the dubious honor of having a Swede, Stefan Ingves, chairing the bank regulatory committee which castrates and de-testosterones our banks.