With Basel II-III risk-weighted capital requirements, banks are not financing the future, only refinancing the past

The pillar of Basel II and Basel III bank regulations is capital requirements based on perceived risk. More-risk-more-capital and less-risk-less-capital.

That results in that banks can obtain much much higher risk-adjusted returns when lending to “The Infallible”, like some sovereigns, the housing sector and the AAAristocracy, than when lending to “The Risky”, like to medium and small businesses, entrepreneurs and start-ups.

And that results in banks lending much more to the “safer” developed past, than to the “riskier” developing future.

And anyone who does not understand that, or fully understands that risk-taking is the oxygen of development, should, frankly, not be working at the World Bank, the world’s premier development bank.

On the risk of risk aversion, I spoke over and over again, as an Executive Director of the World Bank, 2002-2004. But no one wanted to listen, all were just too much in love with the illusion of the ‘never ever a bank crisis again’. And I can understand that, I come from a country, Venezuela, where citizens do believe, over and over again, crazy messianic promises.

And I protested during the High-level Dialogue on Financing for Developing at the United Nations too. But what weight could my small unknown voice carry, when drowned by all those Monday morning quarterbacks, like the Nobel Prize winner Stiglitz, complaining, ex post, about the excessive risk taking of banks.

And it is now more than five years since the bank crisis broke out, precisely because being caught with little capital and excessive exposures to some of “The Infallible”, like AAA rated securities, Icelandic banks, Greece, and real estate in Spain; and our real economy is suffering from the lack of access to bank credit of “The Risky”.

And yet, we still have to read important documents of the World Bank, like Chapter 6 in the World Development Report 2014, “The role of the financial system in managing risks”; and “Financing for Development Post-2015”, which do not even mention the criminal distortions produced by the risk-weighted capital requirements for banks. It makes you want to cry for all the unemployed young.. 

But perhaps there is a glimmer of hope. Professor Stiglitz in "The Changing of the Monetary Guard" in the “Annual Meetings Daily”, October 12, writes about regulations that "affects the supply and allocation of credit - a crucial determinant of macroeconomic activity", and that "Any serious candidate for Fed Chairman should understand the importance of good regulation and the need to return the US banking system to the business of providing credit, especially to ordinary Americans and small and medium sized businesses (that is, those who cannot raise money on the capital markets)”. And that “return”, might mean he, and perhaps some other, have finally understood what happened.

Let us pray that at least Janet Yellen does understand it, especially since those in the Basel Committee and the Financial Stability Board evidence they are still clueless.

What would I do? First we absolutely need to hold the regulators accountable. Fire them, Hollywood would never allow a Basel III to be directed by the same who produced a box-office flop like Basel II… and parade them down some avenues wearing dunce caps.

Then accept that the banking systems is so seriously under-capitalized, and distorted, that extraordinary measures need to be taken, carefully but urgently, Basel IV, if we are not to doom our young unemployed to become a lost generation.

PS. All risk management must begin by clearly identifying those risks we cannot afford not to take… and, in banking, we cannot afford the banks not to take the risks the real economy needs.