Thursday, January 14, 2016
1988 with the Basel Accord, Basel I, the regulators, for the purpose of determining the capital requirements for banks, set the risk weight of the Sovereign (the government) to be zero percent while that of the private sector was set at 100 percent. Have you ever seen something more statist than that?
And in 2004, with Basel II, regulators within the private sector, assigned risk weights that ranged from 20 to 150 percent.
Those risk weights translated into banks needing to hold much less capital (mostly equity) against the Sovereign and the Safe Privates (the AAArisktocracy and houses) than against the Risky Privates (SMEs and entrepreneurs).
That meant banks could leverage their equity much more with Sovereign and Safe Privates, than with Risky Privates.
And that meant banks could obtain much higher risk-adjusted returns on equity with Sovereign and Safe Privates, than with Risky Privates… have you ever heard of something that distorts the allocation of bank credit more than that?
And of course the world ended up with a typical bank crisis, one of those that always result from excessive exposures to something ex ante perceived (or deemed) as safe (AAA-rated securities – Greece), but in this case made so much worse by the banks having been allowed to hold especially little capital against “The Infallible”.
But yet this utterly faulty regulation has been framed in terms of “de-regulation”, which has placed the full blame for the crisis on banks, free markets and capitalism.
How did that happened… who are the responsible for that?
A question: Basel II required banks to hold 1.6 percent in capital against what is AAA rated and 12 percent against the below BB- rated. What do you think poses greater danger to the stability of the banking sector: what’s AAA or what’s below BB-?
Bank capital is to help cover for unexpected losses.
The safer something is perceived the greater the potential of unexpected losses.
No bank crisis ever has resulted from excessive exposures to something ex ante perceived as risky.
Current capital requirements for banks are much lower for what is perceived as risky than for what is perceived as safe.
So the current capital requirements for banks seem to be 180 degrees wrong... could that be?