Current bank regulators are a serious threat to economic growth and financial stability; and they promote inequality.

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?

God make us daring!

World Bank, the credit risk weighted capital requirements for banks promote financial instability and exclusion

May 9-13, 2016 the World Bank will hold “The 13th Overview Course on Financial Issues: Promoting Stable and Inclusive Financial Systems”

And I wonder if they are still going to ignore the distortions produced by the credit risk weighted capital requirements for banks; more risk, more capital – less risk less capital.

These capital requirements allow banks to leverage more with “the safe” than with “the risky”; which means banks will earn higher risk adjusted returns on equity lending to “the safe” than when lending to “the risky”; which means banks will lend too much to “the safe” and too little to “the risky”. And that will:

Promote financial instability since all major bank crisis have always resulted from excessive exposures to something ex ante perceived as safe but that ex post resulted risky.… in this case aggravated by the fact that banks against that hold especially little capital.

Promote exclusion, as it odiously discriminates against the risky… like SMEs and entrepreneurs.

I quote John Kenneth Galbraith from “Money: Whence it came where it went” 1975. “The function of credit in a simple society is, in fact, remarkably egalitarian. It allows the man with energy and no money to participate in the economy more or less on a par with the man who has capital of his own. And the more casual the conditions under which credit is granted and hence the more impecunious those accommodated, the more egalitarian credit is… Bad banks, unlike good, loaned to the poor risk, which is another name for the poor man.”

And when will the World Bank, the world’s premier development bank remind the world of that risk-taking is the oxygen of any development.

Again I quote John Kenneth Galbraith from “Money: Whence it came where it went” 1975. “For the new parts of the country [USA’s West]… there was the right to create banks at will and therewith the notes and deposits that resulted from their loans…[if] the bank failed…someone was left holding the worthless notes… but some borrowers from this bank were now in business...[jobs created]... It was an arrangement which reputable bankers and merchants in the East viewed with extreme distaste… Men of economic wisdom, then as later expressing the views of the reputable business community, spoke of the anarchy of unstable banking… The men of wisdom missed the point. The anarchy served the frontier far better than a more orderly system that kept a tight hand on credit would have done…. what is called sound economics is very often what mirrors the needs of the respectfully affluent.”

In March 2003, as an Executive Director of the World Bank I gave the following formal statement on this:

http://subprimeregulations.blogspot.com/2003/03/financial-sector-assessments-program.html

And soon 12 years later, I am still waiting L