Friday, February 5, 2016
The pillar of regulations designed to keep the banking system safe, is the risk weighted capital requirements for banks.
These, with Basel II, set the risk weight for ‘highly speculative’ below BB- rated assets to be 150%, while the corresponding risk weight, for ‘prime’ AAA rated assets, was set at 20%.
For a basic requirement of 8%, that meant banks needed to hold 12% in capital against ‘highly speculative’ below BB- rated assets, while only 1.6 percent for ‘prime’ AAA rated assets.
That meant banks could leverage their equity, and all the support they receive from society, 8.3 times to 1 when holding highly speculative’ below BB- rated assets; and a mind-boggling 62.5 times to 1 with ‘prime’ AAA rated assets.
That of course distorts the allocation of bank credit to the real economy and, by favoring the access to bank credit for "The Safe", odiously discriminates against that of "The Risky", like SMEs and entrepreneurs.
As is that has banks earning higher risk adjusted returns on what is perceived as safe than on what is perceived as risky, which means banks no longer finance sufficiently the riskier future but mostly stick to refinancing the safer past. ,
And by negating The Risky their fair access to productive bank credit opportunities, inequality can only increase.
But, what I really cannot understand is: How come mature men (and women) can believe that what is rated below BB-, meaning is perceived as ‘highly speculative’, and therefore very risky, can be more dangerous to the banking system, than what is rated AAA, meaning ‘prime’, and therefore perceived as absolutely safe?
No! There has to be something fundamentally wrong with the current mindset of the bank regulators.
Such crazy risk aversion to perceived credit risk should, in The Home of the Brave, be deemed unconstitutional.