Tuesday, April 19, 2016
Risk weighted capital requirements for banks, more perceived risk more capital; less risk less capital, results in the following:
It allows banks to leverage more their equity with what is perceived as safe than with what is perceived as risky; and banks will therefore be able to earn higher expected risk adjusted return on equity on what is perceived as safe than on what is perceived as risky.
And so banks will therefore lend too much and in too easy conditions to The Safe, like to sovereigns, residential housing and the AAArisktocracy; and too little in too harsh terms to The Risky, like SMEs and entrepreneurs.
That has negative consequences for:
Economic growth: It is affected negatively by hindering the access to bank credit of those most likely to open new paths of growth. Now banks are not financing the riskier future, thet are just refinancing the, for the short time being, safer past
Risk of financial instability: It grows since bank crisis never ever result from excessive exposures to something perceived as risky, they always result from excessive exposures to something erroneously perceived as safe. And in this case all is made worse by the fact that when an explosion occurs, the banks will stand there with specially little capital to cover themselves up with.
Inequality: Is promoted by denying “The Risky” a fair access to the opportunities that bank credit can provide.
The regulators have gone mad! You want proof? Here are four of many:
1. The bank regulators are regulating the banks without having defined the purpose of these. Anyone trying to regulate anything without asking what he regulates is for, is as crazy as can be. “A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926
2. In Basel II, June 2004, regulators assigned a 35 percent risk weight to residential mortgages; AAA-rated securities backed with mortgages to the subprime sector carried a 20 percent risk weight; the risk weight for sovereigns rated like Greece, hovered between 0 and 20 percent… but assets rated below BB- carried a 150 percent risk weight.
Who in his sane mind can believe that assets rated below BB- pose a bigger risk to our banking system than those assets believed to be safe?
3. Bank capital is primarily to cover for unexpected losses. Who in his sane mind would estimate unexpected losses based on expected credit losses? If anything what is perceived as safe has greater potential to deliver unexpected losses than what is perceived as risky.
4. Regulators ignored that any risk, even if perfectly perceived, leads to the wrong actions if excessively considered. Credit risk are already cleared for by banks by means of interest rates and size of exposure, so that to also order the same risks to be cleared for again in the capital, completely distorted the allocation of bank credit to the real economy. Who in his sane mind could think that, as a regulator, he was authorized to do a thing like that?