Sunday, May 7, 2017

The insidious credit distorting risk weighted bank capital requirements’ tax, crosses the Laffer Curve at point zero

The Laffer Curve indicates at what rate, a tax will produce less tax revenues for the government.

For purposes of setting the capital requirements for banks in 1988 (Basel Accord) the regulators introduced the risk weighing of banks’ assets. And they decided that loans to the sovereign carried a 0% risk weight, while loans to the citizens (SMEs and entrepreneurs) 100%. 

That means banks need to hold less capital (meaning equity) against loans to the sovereign (meaning government) than against loans to citizens.

That means banks can leverage more their equity with the market risk adjusted interest rates for loans to the sovereign than with the market risk adjusted interest rates for loans to the citizens; which means sovereign will have more and cheaper access to bank loans, a regulatory subsidy, paid by lesser and more expensive access to bank credit for the private sector, a regulatory tax.

That de facto signifies that regulators believe government bureaucrats can make better use of bank credit than the private sector, something that is not true. 

As a consequence of this regulatory distortion, bank credit will not be allocated efficiently to the economy; and so the economy will grow less; and so the tax intake will be smaller; and so the Laffer curve has immediately been crossed. 

Of course, if the current generation does not care about falling tax revenues being compensated with higher debts to be repaid by grandchildren, then this is a moot issue.

PS. Of course all other favoring, like a 20% risk weight for the AAA-risktocracy and 35% for residential housing also to misallocate credit... and thereby cause less ordinary tax revenues. 

PS. Of course, sadly, nothing is gained in term of stability, as never ever do major bank crisis result from excessive exposures to something perceived risky. These results from excessive exposures to something perceived safe, like sovereigns like Greece, like AAA rated securities.