Monday, October 5, 2015

Q. Watson, what about requiring banks to hold more capital against risky assets than against safe? A. Dumb!

Let me explain:

If banks must hold more capital against assets perceived ex ante as risky than against assets perceived as safe then: banks will earn higher risk adjusted returns on equity for assets perceived as safe than for assets perceived as risky; and that distorts the economic efficient allocation of bank credit to the real economy, which of course attempts against a vital purpose of banks.

More dumbness: Since major bank crisis always occur because something ex ante perceived as safe turns out ex post as very risky, this would guarantee that banks stand there with the pants down and little capital to cover themselves up, precisely when they most need it.

More dumbness: Bank capital is required in order to cover for unexpected risks so as to estimate these based on the expected losses from perceived credit risks is, to put it delicately, not smart at all.

More dumbness: To make it more difficult for The Risky, like SMEs and entrepreneurs to have fair access to bank credit, does certainly produce increased inequality

Do you want me to keep going on its dumbness?

What about this? The risk weight for those that being perceived as safe could pose so much danger for the banking system like the AAA rated, was set at 20% in Basel II. The risk weight for those totally innocuous below BB- rated, was set at 150%.

No Mr Watson, that should be more than enough. Thank you. I will immediately call the Basel Committee, the Financial Stability Board and the IMF, and suggest they consult you on this delicate matters, that in my opinion is taking our economies down.