World Bank and IMF, is the stability of banks really a good growth (or stability) strategy?

The most important “New Growth Strategy” that has been put in effect by global authorities during the last decades, is the one based on the notion that as long as our banks are stable, the economy will grow and everything will be fine and dandy.

And, in order to foster that stability of the banks, the Basel Committee for Banking Supervision designed a system of ex ante perceived credit-risks weighted capital (equity) requirements, which translates into: more-risk-more-equity, less-risk-less-equity. 

And that allows banks to be able to earn much much higher risk-adjusted returns on equity when lending to “the infallible” than when lending to “the risky”.

And, of course, the result was just as could have been expected… huge exposures to the infallibles, like to AAA rated securities (subprime mortgages USA), sovereigns (like Greece) and real estate (Spain)… and no exposures at all to the risky, like to medium and small businesses, entrepreneurs and start ups.

So how has that strategy worked? I would dare say “quite lousily”… but I might be wrong… because I see most of you feel like it is ok for those responsible for Basel I and Basel II, to now have a go at Basel III, that is if they are not to take up even higher responsibilities, like that of chairing the ECB.

I have always thought that risk taking was the oxygen of development, and that secular stagnation, deflation, mediocre economy, unemployment, underemployment, managed depression and all similar obnoxious creatures, were all direct descendants of risk aversion. But, then again I might be wrong, especially considering that the world’s premier development bank, has not objected one iota to that artificial regulatory risk aversion 

Looking back at history I have also always thought that what really posed dangers to the stability of banks, was what is perceived ex ante as absolutely safe. That because there is were the real dangerously large exposures could be found, never among the risky, But, then again I might be wrong, especially considering that the world’s premier financial stability agent, has not objected one iota to that structure of incentives for the allocation of the portfolios of banks.

It will be very interested to hear what renowned experts like Andreu Mas-Collel, Dani Rodrik, Philippe Aghion, Arvind Subramanian, Ivan Rossignol will have to say about that when, on October 14, they discuss in Washington: “New Growth Strategies: Delivering on Their Promise?” Sorry I can't be there (well not that sorry, since I will be in Paris :-))

PS. And, while you’re at it, if you can spare a second, give a thought to whether the risk-weighted bank capital requirements are helpful in order to decrease inequality or financial exclusion… or if perhaps they may serve as drivers of that.

PS. And, while you’re at it, if you can spare a second, give a thought to whether injecting some purpose into bank capital requirements could do some good, like instead of using credit ratings, using perhaps potential of job creation ratings, sustainability of planet earth ratings, and good governance and ethics ratings of governments.