Tuesday, March 1, 2016
I refer to Charles Goodhart’s “The Basel Committee on BankingSupervision: A History of the early years 1974-1997” 2012, Cambridge Press.
Goodhart frequently mentions the importance given by bank regulators “towards preserving and, where necessary, enhancing national prudential standards and towards removing competitive inequalities arising from different regulatory requirements” (p.175)
But since the need for an efficient allocation of bank credit to the real economy was never in any way shape or form on the regulators’ agenda, while doing so they came up with risk weighted capital requirements for banks; which guaranteed unleveling the playing-field for all bank borrowers, by favoring the “safe” in detriment of the “risky”.
Goodman (p.195) writes “the risk weights to be applied to the various groups of assets were ad-hoc and broad-brush, based on subjective (and political judgement), not on any empirical studies. Their application soon led to serious distortions in bank bank asset portfolios that undermined Basel I. There was little or no discussion at the time about the impact that the Accord might or should have on bank behavior. The need was just to achieve the two desiderata: higher capital ratios and a level playing field” (p.195)
And since the need for an efficient allocation of bank credit to the real economy was never, in any way shape or form part of the regulators’ agenda, they came up with risk weighted capital requirements for banks; which guaranteed and unlevel-playing-field for all bank borrowers, by favoring the “safe” in detriment of the “risky”. And with respect to the health and growth of the real economy, that was as imprudent as imprudent can be.
Goodman opines “any simple approach would tend to put into common groupings (or ‘buckets’) assets/liabilities that were in many respects dissimilar, thereby leading to anomalies, distortions and ‘gaming’” (p.158). I do not agree. It was the existence of different buckets, which received different capital requirements treatments, that led to distortions and gaming. Any assets might have arrived to a specific bucket by means of gaming, but once in that bucket, within that bucket, there were no further distortions as the risk weights were all the same.
In an undisturbed real economy, there is only one bucket, in which all have to live and fight for survival.