Monday, May 18, 2015

The World Bank spoke out way too softly on faulty bank regulations, and finance ministers did not read carefully enough.

World Banks' The Global Development Finance 2003 (GDF-2003), “Striving for Stability in Development Finance” had this to say on Basel II, pages 50-52

“The new method of assessing the minimum-capital requirement [proposed by the Basel Committee for Banking Supervision (BCBS)]… will be explicitly linked to indicators of credit quality… The regulatory capital requirements would be significantly higher in the case of non-investment-grade emerging-market borrowers than under Basel I. At the same time, borrowers with a higher credit rating would benefit from a lower cost of capital under Basel II….

A recent study by the OECD (Weder and Wedow 2002) estimates the cost in spreads for lower-rated emerging borrowers to be possibly 200 basis points.”

What did the World Bank say with that?

It said that regulatory capital requirements would distort more than the previous Basel I did, the allocation of bank credit.

What did finance ministers of developing countries do?

They did not protest that as an outrageous odious discrimination of bank lending to countries like theirs that are naturally perceived as more risky.

What did finance ministers of developed countries do?

They did not understand that their own “risky”, the SMEs and entrepreneurs, would be exposed to exactly that same odious discrimination.

I, at that time an Executive Director of the World Bank, mostly representing developing countries, when commenting GDF-2003 formally stated:

“the document does not analyze at all a very fundamental risk for the whole issue of Development Finance, being that the whole regulatory framework coming out of the BCBS might possibly put a lid on development finance, as a result of being more biased in favor of safety of deposits as compared to the need for growth. Even though, in theory, we could agree that there should be no conflict between safety and growth, in practice there might very well be, most specially when the approach taken is by substituting the market with a few fallible credit rating agencies.”

And a couple of weeks later, also formally at the Board of the World Bank I held: “BCBS dictates norms for the banking industry that might be of extreme importance for the world’s economic development. In BCBS’s drive to impose more supervision and reduce vulnerabilities, there is a clear need for an external observer of stature to assure that there is an adequate equilibrium between risk-avoidance and the risk-taking needed to sustain growth. Once again, the World Bank seems to be the only suitable existing organization to assume such a role."

Now I hear some talking about that the World Bank is becoming irrelevant. Forget it! It could be more relevant than ever… but for that it has to be able to stand up for the risk-taking our children needs for us to take in order for their children to have a future.

PS. Come to think of it. The World Bank has been mum on this regulatory distortion of the allocation of bank credit to the real economy. Why? Does it not even listen to itself?