Friday, March 31, 2017
The Basel Committee (and national bank regulators) allows banks to hold less capital against assets perceived or decreed as safe, like loans to sovereigns, to what has an AAA rating or residential mortgages, than against assets perceived as risky, like loans to SMEs and entrepreneurs.
That means banks can leverage more their equity with “safe” assets than with “risky” assets.
That means banks can earn higher risk adjusted returns on equity on “safe” assets than on “risky” assets.
That means banks will acquire too many safe assets and too little risky assets.
But, you might ask, is that not great? The answer is, NO!
It guarantees that the real economy will be negated the risk-taking necessary for it to keep on moving forward so as not to stall and fall.
“A ship in harbor is safe, but that is not what ships are for.” John A Shedd (1850-1926)
And it guarantees that, sooner or later, (like in 2007-08 with AAA rated securities and Greece) banks will end up holding, against too little capital, too much of an asset ex ante perceived as safe, but that ex-post turns out to be very risky.
“May God defend me from my friends, I can defend myself from my enemies” Voltaire
And of course that meant that bank regulators decreed inequality.