Tuesday, March 8, 2016

Regulators introduced into banking a very serious systemic error that is being totally ignored

Banks used to evaluate all credit applications based on the same own bank capital, because that was on the margin true. And so all borrowers could compete with their cost and risk adjusted interest rates offers, on equal terms. Not any longer.

Since the introduction of the risk weighted capital requirements for banks, more perceived risk more capital – less risk less capital, the offers from different borrowers will be evaluated based on different levels of bank capital.

Since the offers provided by The Safe can be leveraged more by the banks than the offers provided by The Risky, The Safe have now a regulatory advantage that, when compared to The Risky, allows them a preferential access to bank credit.

And that seriously distorts the allocation of bank credit to the real economy. “The Safe” get more and cheaper access to bank credit while The Risky, like the SMEs and entrepreneurs, they get less and more costly bank credit. 

To argue that to be a very serious systemic error seems very obvious to me but, in all the discussions on bank regulations, that error has been completely ignored. Why?

For instance, I might have written to the Financial Times and its various reporters and columnists over a thousand letters about it, but its editor has preferred to keep total silence. It must be because of something much more important than perhaps FT thinking little me a nuisance since I write too many letters to the editor.

And of course, in terms of bringing more stability to the banking system, that regulation is absurd and useless. The risk for the system of what is ex ante perceived as safe, but that ex post could be very risky, is clearly much higher than the risk for the system of what is ex ante already perceived as risky.

And of course, the creation of predatory regulations that subsidize The Safe and penalize The Risky, can only accentuate existing inequalities