To obtain loans sovereigns don’t need to threaten lenders with dungeons anymore. They now have the Basel Committee.

In Yuval Noah Harari’s “Sapiens: A brief history of humankind” we read: “The king of Spain desperately needs more money to pay his army. He’s sure that your father has cash to spare. So he brings trumped-up treason charges against your brother. If he doesn’t come up with 20.000 gold coins forthwith, he’ll get cast into a dungeon and rot there until he dies”

Nowadays sovereigns are much more intelligent and much less transparent. They appoint their expert technocrats to the Basel Committee for Banking Supervision and who, for the purpose of setting the risk weighted capital requirements for banks, assign a 100 percent risk weight to the private sector and a zero percent risk weight to the sovereign.

Read more about the horrors of the Basel Accord of 1988, and which no one protested.

How come American citizens did not protest the Basel Accord’s 1988 in your face statism?

I refer to:

Confidential Memorandum:

Attack of American Free Enterprise System

Date: August 23, 1971

To: Mr. Eugene B. Sydnor, Jr., Chairman, Education Committee, U.S. Chamber of Commerce

From: Lewis F. Powell, Jr.

It mentions "The Ideological War Against Western Society"

But I sure have a question for you all

In 1988, by means of the Basel Accord, Basel I, for the purpose of setting the risk weights applicable to the credit risk weighted capital requirements for banks, the regulators defined a zero percent risk weight for the OECD sovereigns (governments) and a 100 percent risk weight for the citizen (the private sector)

That meant that governments would have more favorable access to bank credit than the citizens; which de facto implied that government bureaucrats use bank credit more efficiently than citizens.

There were protests from other sovereigns who also wanted to be awarded a zero percent risk weight… but how come no American citizens protested this in your face statist regulation?

Is not the strength of a sovereign solely the reflection of the strength of its citizens?

That distortion subsidizes government debt; with the subsidy paid for all those in the private sector who as a consequence will, in relative terms, have less and more expensive access to bank credit?

Is this of no interest to America?

If so then America is not what I had learned to believe and admire.

Excuse me Stefan Ingves. Are you a raving statist? Are you a raving communist?

In 1988, with the Basel Accord, Basel I, the bank regulators of the all important G10 decided that, for the purpose of defining the capital requirements of banks, the risk weight for the sovereign, meaning the government, was to be zero percent, while the risk weight for the private sector, meaning the citizens, was set at 100 percent. What a lunacy!

Mr Stefan Ingves, Chairman of the Basel Committee on Banking Supervision and Governor of the Sveriges Riksbank, in remarks made on May 5, 2015 to the 8th Meeting of the Regional Consultative Group for Europe, had this to say about “Sovereign risk”

“A discussion of the risk-weighted capital framework would not be complete without a discussion of the Committee's work on sovereign risk - a topic which is clearly of relevance to Europe. At its meeting earlier this year, the Group of Central Bank Governors and Heads of Supervision - the Basel Committee's oversight body - agreed to initiate a review of the existing regulatory treatment of sovereign risk, including potential policy options.

In many cases sovereign exposures are in fact relatively low credit risk assets and also highly liquid. 

Yes, they do receive a lower capital charge than other asset classes, but this is generally warranted. But - and this is an important but - I think we can all agree that there is no such thing as a risk-free asset. When we talk about this issue we talk about "sovereign-risk" - not about "sovereign risk-free"

For this reason the Committee will consider potential policy options related to the existing treatment of sovereign risk. It is important to note that this review will be conducted in a careful, holistic and gradual manner.”

Let me here concentrate on “Yes, sovereigns exposures do receive a lower capital charge than other asset classes, but this is generally warranted.”

Mr. Stefan Ingves, why is that generally warranted?

If sovereigns exposures receive a lower capital charge than other assets that means banks will be able to leverage more their equity and the support they receive from society when lending to the sovereign than when lending to the private sector, meaning to the citizens. 

And that of course means banks will be able to earn higher expected risk adjusted returns on equity when lending to sovereigns than when lending to the private sector, meaning to the citizens.

And that of course means banks will tend to favor lending to the sovereigns than to the private sector, meaning the citizens.

And the only possible rational explanations for that must be if you believe government bureaucrats more able than citizens to use bank credit.

Do you Stefan Ingves believe that? Are you a raving statist? Are you a raving communist?

Who has ever heard about a zero percent risk free sovereign? They even tell you in your face that they have an inflation target, so as to pay you off with money worth less and, if that does not suffice, that they will then increase your taxes to service their debt.

Do we really want to bet our economies on government bureaucrats using bank credit better than SMEs and entrepreneurs?

Those who protest government austerity the loudest are frequently those who most want to force banks to increase their capital. Let us analyze the implications of that position:

If governments are not going to be austere and spend more, and consequentially run deficits, it is only natural governments will need to take on more debt.

If banks are forced to hold more capital then, while the banks find more capital and adjust their business models to those new realities, there is going to be quite a lot of austerity when it comes to the supply of bank credit to the economy.

Since current capital requirements for banks are lower when lending to the government than when lending to the private sector, that will generate a bank credit squeeze on the private sector, affecting most especially those against which loans banks needs to hold more equity, like the SMEs and the entrepreneurs.

The only way to bridge the contradiction between government austerity being something bad for the economy, and bank credit austerity something good for the economy, is of course by believing that government bureaucrats can use bank credit more efficiently than SMEs and entrepreneurs. And that friends, is a truly doubtful proposition on which to bet the future of our economies.

Citizens, it behooves us to unite much more than what government bureaucrats/technocrats unite.

Greece urgently needs lower capital requirements for banks when lending to SMEs than when lending to its government

Between June 2004 and November 2009 thanks to Basel II, banks were allowed to lend to the Government of Greece against only 1.6 percent in capital while requiring banks to hold 8 percent in capital when lending to the private sector.

That meant that banks could leverage their equity 62.5 times lending to the Government but only 12.5 times when lending to the private sector.

That meant, of course, that banks ended up lending much too much to the government and much too little to the private sector, like to Greek SMEs and entrepreneurs.

And here we are with Greece stuck in the doldrums and not finding its way out.

If I were its doctor, I would immediately recommend that banks should be allowed to hold less capital when lending to the private sector than when lending to the government. Since the private sector is the heart of the economy it is very urgent it gets out of it flat-line, by banks pumping the oxygen it needs.

Just before the Berlin Wall felt, communists, statists, dictators and those who benefit from crony statism, gave the liberal capitalistic free-market world the finger.

In 1988, just before the fall of the Berlin Wall in 1989, some communists/statists hacked into the free market capitalist world’s bank regulations. By means of Basel I, and for the purpose of determining the capital requirements for banks, they arranged so that the risk weight for lending to OECD sovereigns was zero percent, the risk weight for lending secured with houses 50 percent, while the risk weight for lending to the private sector was set at 100 percent.

Since the basic capital requirement was set at 8 percent that meant that banks could leverage their capital unlimited times when lending to sovereigns, 25 times (100/4) when financing the purchase of houses and 12.5 times to 1 (100/8) when lending to the private sector... citizens. 

That doomed bank to lend too much to the governments and too much to the housing sector, and basically to abandon the traditional role of banks, namely to provide credit for the private sector, like to SMEs and entrepreneurs. Of course those from the private sector that were exploiting crony statism, they just loved it. 

That de facto reflected the belief that government bureaucrats know better what to do with bank credit they are not personally liable for, than for instance entrepreneurs.

And that in turn doomed the liberal free-market and capitalistic economies of the western world.

That the world suffers under the thumb of neo-liberalism? That's a sad fake-news cover up the statists invented.

How much public debt would have been avoided, or at least priced correctly if banks, when lending to the sovereign, needed to hold that same 8% they were required to hold when lending to the citizen?

Please, for the good of our grandchildren, it might already be too late for our children, help me tear down that wall the Basel Committee built… urgently … Greece was just the tip of the iceberg!

PS. On that day, financial communism was decreed

PS. November 2019, there will be 30 years since the world went from “Tear Down that Wall” to the “Build Up that Wall” for 30 years.

PS. Here is an aide memoire on the mistakes in the risk weighted capital requirements for bank made so much worse with the introduction of Basel II in 2004.

A letter to the Financial Stability Board

A letter to the IMF titled: "The risk weights are to access to credit, what tariffs are to trade, only more pernicious."