Should we not expect the Fed to do something if they hear they are distorting the allocation of bank credit?

I refer to the letter from Managed Funds Association to the Board of Governors of the Federal Reserve System titled “Supplemental Comments in Response to Federal Reserve Staff Questions on Managed Funds Association Regulatory Priorities”

In it, discussing “the flow-through impacts of the supplementary leverage ratio (SLR) on the buy- side’s use of centrally cleared derivatives” MFA comments: 

“At present the SLR is having a more direct impact on banks… [there are] cases in which certain banks have exited the clearing business altogether,or have reduced client clearing services.

Of course, banking organizations allocate capital to business lines based on expected returns. As such, an organization will use its balance sheet to fund businesses that can meet return-on-equity (“ROE”) targets given the amount of capital required to be held against the activities of each business.”

That is a crystal clear explanation (or confession) that bank’s business lines ROE targets are adjusted by “the amount of capital required to be held against the activities of each business.”

So therefore it should be crystal clear that whatever is ex ante perceived, decreed or can be concocted as safe, currently, because of the risk weighted capital requirements for banks, can easier meet the ROE targets of banks than what is perceived as risky.

So therefore it should be crystal clear the “safe” financing of house purchases, sovereigns and AAA rated securities, will stand too much better chances to meet the ROE targets of banks than the financing of “risky” entrepreneurs or SMEs.

So therefore it should be crystal clear that house purchases, sovereigns and AAA rated securities will obtain much easier credit, and that entrepreneurs or SMEs will see their difficulties to access credit only be increased.

Damn that distortion!

By giving banks the incentives to further increase, against especially little capital, the exposures to what being perceived as “safe” always represent the detonators, they set bank crisis on steroids.

By giving banks the incentives to further reduce the exposures to what’s “risky”, that dooms the economies to stagnation.

And as usual, most probably the Board of Governors of the Federal Reserve System won’t care one iota about that, as they until now see as their only bank regulatory role, that of keeping the banks as safe mattresses into which to stash away cash… and never concern themselves whether these mattresses might be infested by the lice of dangerous uselessness.