What a bank regulator could be asking himself on his deathbed…

Even though I knew that the capital I should require a bank to hold was primarily a protection against unexpected losses… how could I have been so dumb so as to base the capital requirements on the perceptions about the expected losses?

And how could I have been so dumb so as to accept “portfolio invariant” capital requirements, which obviously does not consider the danger of excessive exposures to what is perceived as “absolutely safe”, nor the benefits of diversification among what is considered as “risky”?

That caused of course banks to make much much higher risk-adjusted returns on equity when lending to “the infallible sovereigns” and the AAAristocracy than when lending to the “Risky”.

And that caused banks to overpopulate some “safe havens” turning these into deadly traps, like AAA rated securities, Greece, real estate in Spain; and equally dangerously to under-explore the more risky but more productive bays, represented by medium and small businesses, the entrepreneurs and the start-ups.

And with all that I helped to screw up the whole Western world economy... especially Europe's

I know most of the world will not forgive me, but I sure pray for that my unemployed children and grandchildren understand that, though admittedly I was very dumb and arrogant, I did not regulate so dumb on purpose… in fact my whole problem began when I and my colleagues started to regulate the banks without even caring to define their purpose.

Two facts on Basel I, II and III

The first fact is that since banks are allowed to hold less capital, and therefore to leverage the risk-adjusted margins more on their capital, and therefore to obtain much higher expected returns on equity when lending to what is perceived as “safe” than when lending to what is perceived as “risky”, current regulations are completely distorting our financial system. 

That has caused banks to create excessive exposures to what was erroneously perceived as risky, like in AAA rated securities, Greece, real estate, and to refrain from lending to those in the real economy perceived as “risky”, like small businesses and entrepreneurs. 

The second fact is that the first fact is not even mentioned, much less discussed. 

What is the Basel Committee’s Stefan Ingves now saying, “risk-adjusted (regulatory) returns”?

Stefan Ingves, the Chairman of the Basel Committee in “Where to next? Priorities and themes for the Basel”, a speech delivered on March 12, in page 5 of transcripts, says: 

“The major reforms…that have been developed by the Committee…intended to generate a more resilient financial system, in which higher levels of capital and liquidity are held, and in which risk is appropriately managed and priced. This will obviously have consequences for the costs of financial intermediation, although studies undertaken suggest that this cost is both relatively small, and considerably outweighed by the benefits of increased financial stability. 

Nevertheless ... The Committee is mindful of two potential consequences from the programme of reforms. 

While a degree of deleveraging and increased risk premia are intended consequences of the reforms, there is always a danger that some unintended consequences may arise… 

A second potential consequence relates to the incentives that may arise as the banking sector adapts to the reforms by moving into those businesses where risk-adjusted (regulatory) returns are greatest. This reshaping of banking (either within bank balance sheets or outside the regulated banking system) needs to be monitored on an ongoing basis…” 

What Mr Ingves? “risk-adjusted (regulatory) returns”? This is the first time I read the Basel Committee admitting it is (hopefully unwittingly) distorting the markets, and thereby making it impossible for the banks to efficiently allocate economic resources.

It is not about banks arbitraging opportunities between bank balance sheets or outside the regulated banking system, something quite frequently discussed, but about arbitrating “within bank balances”. 

And so it is not about risk-adjusted bank returns, appropriately managed and priced, something perfectly natural, but about “risk-adjusted (regulatory) returns”. 

In other words, it is about the Basel Committee deciding about where banks can obtain higher or lower returns. 

In other words, as I have argued for a decade, it is not about the credits our banks give out being guided by the markets invisible hand, but by the Basel Committees invisible (and unaccountable) hand. 

Who the hell authorized you Basel Committee bureaucrats to do that? 

And then, “... studies undertaken suggest that this cost is both relatively small”. 

Basel Committee, I dare you to show those studies… If you think, like in Basel II, that authorizing banks to leverage 62.5 times to 1 when lending to a AAA rated client but only 12.5 to 1 when it is an unrated “risky” borrower, has only “relative small” effects on the interest rate that the unrated “risky” borrower has to pay in order to make up for the discrimination, you simply have no idea what you are talking about. 

And then “…this cost [is] considerably outweighed by the benefits of increased financial stability” 

Basel Committee, please, don’t mock us, what stability?