Can you imagine? XXX does not understand…

… how the risk-weighted capital requirements for banks completely distorts the allocation of bank credit in the real economy.

Let me try to explain it to XXX again.

If there was no risk weighing of Basel II’s 8 percent capital requirements for banks, then the banks would allocate their credit in the real economy, based on who produces the highest risk-adjusted return on eight units of bank capital for each 100 units of loans. 

But there is risk weighing in Basel II, and so banks allocate their credit, for instance to the private sector, in terms of:

For those rated AAA to AA, risk weight of 20%, based on who produces the highest risk-adjusted return on 1.6 units of bank capital for each 100 units of loans.

For those rated A+ to A, risk weight of 50%, based on who produces the highest risk-adjusted return on 4 units of bank capital for each 100 units of loans.

For those rated BBB+ to BB-, and those unrated, risk weight of 100%, based on who produces the highest risk-adjusted return on 8 units of bank capital for each 100 units of loans.

For those rated AAA to AA, risk weight 20%, based on who produces the highest risk-adjusted return on 1.6 units of bank capital, for each 100 units of loans.

And so of course those perceived as “safer” produce banks much higher risk-adjusted returns on their equity than those perceived as riskier.

And that of course causes banks to lend more than what they should to those perceived as “safe”, like the “infallible sovereign” and the AAAristocracy, and much less, sometimes even nothing, to those perceived as “risky”… like to medium and small businesses, entrepreneurs and start-ups.

But, amazingly, XXX has not understood that this completely upsets the price-risk equation in the markets, and thereby, as said before, completely distorts the economically effective allocation of bank credit in the real economy.

What are we to do with XXX? XXX is though a very influential figure… and too many find it so difficult to believe XXX could really have been so wrong.

And what is history going to say about, for instance Europe, falling into the hands of nerdy sissies who cannot understand that what is safe today, is the result of a lot of risk-taking yesterday, and that our children and grandchildren has the right to expect from this generation, to also incur in its share of risk-taking… so that they too have a future and decent jobs.

PS. And to top it up, all for no good reason, since all big bank crises have always resulted from excessive exposures to what was ex ante perceived as “absolutely safe”… and none because of excessive exposures to something ex ante perceived as “risky”.