Monday, February 8, 2016
The Basel Committee first published their Core Principles for effective banking supervision in 1997, their “de facto minimum standard for sound prudential regulation and supervision of banks”. The latest version, from 2012, now includes 29 Core Principles.
It makes for a harrowing read. Of the 29, 16 have explicitly to do with what the supervisor “determines”, “sets”, “defines” or “requires”. And Principles 8 and 9, on the Supervisory Approach Techniques and Tools to be used when regulating banks, reads like an arrogant meddling bureaucrat’s wet dream.
There is not one single reference to the possibility that regulations could, with tragic consequences, interfere with the allocation of bank credit to the real economy.
Consider their Principle 16 – on capital adequacy: “The supervisor sets prudent and appropriate capital adequacy requirements for banks that reflect the risks undertaken by, and presented by, a bank in the context of the markets and macroeconomic conditions in which it operates. The supervisor defines the components of capital, bearing in mind their ability to absorb losses.”
That lead to the pillar of current regulations the risk weighted capital (equity) requirements for banks. The higher ex ante perceived or deemed risk of assets the higher the capital requirement; the lower the ex ante perceived risk of assets the lower the capital requirement.
And that means banks can leverage their equity more with assets perceived as safe, than with assets perceived as risky; and that results of course in that banks earn higher expected risk adjusted returns on their equity on assets perceived as safe, than on assets perceived as risky.
And so that favored more than what was normal bank lending to The Safe, like sovereigns, the AAArisktocracy and housing; and hindered more than what was normal, any bank lending to The Risky, like to SMEs and entrepreneurs.
And since excessive bank lending, against too little capital, to what was ex-ante perceived as very safe but that ex post turns out as very risky, is precisely the stuff major bank crises are made of, bank regulators have set the whole bank system on course to major disasters.
And since insufficient lending to those who on the margin are most likely to move the economy forward, so as it will not stall and fall, like the SMEs and entrepreneurs, bank regulators have set the economy on course to major disasters.
And consider their Principle 17 – on credit risk: “The supervisor determines that banks have an adequate credit risk management process that takes into account their risk appetite, risk profile and market and macroeconomic conditions. This includes prudent policies and processes to identify, measure, evaluate, monitor, report and control or mitigate credit risk (including counterparty credit risk) on a timely basis. The full credit lifecycle is covered including credit underwriting, credit evaluation, and the ongoing management of the bank’s loan and investment portfolios.”
And the question is… how can you have adequate credit risk management when regulators also force you to clear in the capital the perceived credit risk you already clear for when deciding the risk premium and the size of the exposure?
And also ask yourselves… Why should the risk adjusted expected net margin paid by the risky to the banks be worth less than that paid by the safe? And then you will begin to understand how this regulation curtail opportunities to access bank credit and thereby increases inequality.
In other words regulators, insufflated with exaggerated estimates of their own abilities, are leading our banks and our economies to disaster.