Saturday, September 12, 2015
We have been made aware that currently banks are required to hold more capital, meaning equity, when lending to those perceived as safe from a credit risk point of view, like many sovereigns and private entities with good credit ratings, than what banks need to hold in capital when lending to those perceived as more risky, like SMEs and entrepreneurs.
Notwithstanding that sounds intuitively as quite reasonable, one can also argue the following:
Those perceived as safe from a credit point of view, without these regulations, already count with the benefit of larger loans and lower interest rates; while those perceived as risky have less access to bank credit and have to pay higher interest rates. Mark Twain’s saying that a banker is he who lends you the umbrella when the sun shines, but wants it back when it looks like it is going to rain, comes to mind.
So these capital requirements allow banks to leverage more their equity, and the support they in many ways receive from society, many times more when lending to The Safe than when lending to The Risky; and so banks can earn much higher risk adjusted returns on equity when lending to The Safe than when lending to The Risky.
As a result, these capital requirements enlarge the natural differences in access to bank credit between The Safe and The Risky. For instance we could say these regulations artificially favors American banks lending to European sovereigns and highly rated corporations, over lending to American small businesses and entrepreneurs.
And so we must ask you:
Q. Is such regulatory risk-aversion, which distorts the allocation of bank credit, a valid principle for regulating banks in the Land of the Free and the Home of the Brave?
Q. Do we not owe our descendants the same willingness to take risks as that which our fathers allowed our banks to take to get us here?
Q. Cannot it be said of such regulations, by creating incentives for these to refinance the safer past, impede banks from financing the riskier future?
Q. Is not fair access to bank credit an indispensable part of generating the opportunities that helps to reduce inequalities?
Q. Do we not have something called the Equal Credit Opportunity Act, Regulation B, which would seem to forbid this type of regulatory discrimination?
Q. Since the purpose of capital requirements for bank is to shield it against unexpected losses, how can it be you base these on the expected credit losses?
Q. Since what is perceived as risky never generate dangerous excessive financial exposures, that honor goes to what is perceived as safe but ends up being risky, do these regulations really help to build up a safer banking system?
Thank you... oh by the way, since I also heard that your capital requirements are portfolio invariant it just occurred to me to also ask: Should we not require banks to hold capital against the risk of their exposures instead of the credit risk of their assets?