Thursday, December 10, 2015
When any borrower pays a bank interests, that payment contains an expected net profit margin for the bank, and of course, that margin, is after taking into account all expected credit risks.
And it used to be that all borrowers competed on equal terms for access to bank credits, by offering banks their respective, equally valued, net profit margins.
But that was before. Beginning 1988, with the Basel Accord, and exploding in 2004, with Basel II, bank regulators, in order to make banks safer, so they thought and still think, came up with credit risk weighted capital requirements for banks.
This signified banks had to hold more capital against what was perceived as risky, than against what was perceived as safe; meaning banks could leverage their equity (and the support they received from society) much more when holding assets perceived as safe that when holding assets perceived as risky.
And so, suddenly, the net profit margins offered by those perceived as safe, were and are worth to banks, much more than the net profit margins offered by those perceived as risky.
And that leads of course that those perceived as safe, and who therefore already enjoy more and cheaper access to bank credit, are favored even more; while those who because they are perceived risky already suffer less and more expensive access to bank credit, are even more disfavored.
The consequence is tragic.
Since major bank crisis never result from excessive exposures to something ex ante perceived as risky, but always from excessive exposure to something wrongly believed to be safe, it guarantees that when crisis occur, banks will stand there with especially large exposures and especially little capital to cover themselves up with.
And by distorting the allocation of bank credit in favor of what is perceived as safe it impedes banks from sufficiently financing that which is perceived as risky, like SMEs and entrepreneurs. And that denies the real economy the kind of risk taking it needs in order to move forward and not stall and fall.
And of course, by denying "the risky", usually those with less, fair access to the opportunity of bank credit, it is a major driver of inequality.
How did this happen? The clearest explanation is that bank regulators full of hubris, never cared to concern themselves with defining the purpose of banks before regulating these.
Though not a bank regulator, I have been objecting, in a thousand ways, for soon two decades, these credit bank regulations; but I have yet not been able to extract one clear or unclear explanation, one valid or invalid justification, or anything that looks like a public answer to my objections by any regulator. I know some of them are concerned, but seemingly it is a too hot potato for them to handle.
Our current bank regulators simply do not have the courage to stand up for what they have done.
Our banks have a purpose that is much more important than just being safe, and that is to help finance a good future for our children and grandchildren. God make us daring!
PS. And all those on the road of becoming the oldies of turn, they should never forget that the most important part of any pay-as-you-go pension system, is the how-it-goes-part.
PS. Since in Basel I the risk weight for sovereigns (governments) was set as zero percent, while the risk weight for that private sector that gives the sovereign its strength was set to be 100 percent, another explanation is that these regulators are just simple statist or communist infiltrators.