When will bank regulators stop making bankers’ wet dreams come true and do more for the beautiful dreams of our young?

What is a banker’s wet dream? Presumably to earn a lot of return on equity while not having to take risks. And the regulators granted that dream by allowing banks to have especially little capital against assets perceived as safe. Little capital means high leverage, and which means high-expected risk adjusted returns on equity. So banks just refinance the "safer" past.

What could our young ones dream of? To find decent jobs that allows them to form families and earn sufficiently to maintain these well. And that we know requires a lot of SMEs and entrepreneurs to open up new roads and ways to jobs in the real economy. But these dreams are denied by the regulators when requiring banks to hold more capital when lending to the “risky” than when lending to the safe. More capital means lower leverage, and which means lower expected risk adjusted returns on equity. So banks do not finance the "riskier" future.

And the current nightmare is that regulators are not even aware of what their credit risk aversion is doing. “A ship in harbor is safe, but that is not what ships are for.” John A Shedd

And the current nightmare is that regulators are not even aware that for the banking system, what’s perceived as safe, is the only that can generate those dangerous excessive exposures that bring on crises.  “May God defend me from my friends [what’s safe]: I can defend myself from my enemies [what’s risky]” Voltaire

Here is an aide-mémoire that explains some incredible mistakes in the risk weighted capital requirements for banks, the pillar of current regulations.

Basel Committee, dare subject your risk weighted capital requirements for banks to a referendum… or at least dare answer my objections.

You hold: More ex ante perceived credit risk more capital, less ex ante perceived credit risk less capital.

I hold: It is not the ex ante perceptions of risk that matter, it is only the ex-post realities that do. And in this respect, what is perceived as risky is in fact usually safer than what is perceived as safe.

I hold: Bank capital should be there against unexpected losses not against expected credit risk losses.

I hold you never analyzed what causes bank crises you just analyzed what problems bank borrowers could face, and that far from being the same. 

I hold: To allow banks to leverage differently their equity and the support society and taxpayers give these differently, based on ex ante perceived credit risks; which allows banks to earn higher risk adjusted returns on equity on what is perceived as safe than on what is perceived as risky, distorts dramatically the allocation of bank credit to the real economy.

I hold like John A Shedd: “A ship in harbor is safe, but that is not what ships are for.” 

I hold like Voltaire: “May God defend me from my friends [AAA rated]: I can defend myself from my enemies [BB- rated]”

I hold that because of the dumb risk aversion in your regulations, banks no longer finance the riskier future our children needs to be financed, they only refinance the, for the short-time being, safer past.

I hold that when you set the risk weights of sovereigns at zero percent, but that of the citizens at 100 percent, you introduced statism through the back door. In fact Sovereign = 0% and We The People = 100% sounds sort of like a regulatory Ponzi scheme.

To sum up, Basel Committee, I hold you have clearly evidenced you have no idea of what you are doing.

God make us daring!

When it comes to discrimination, EU cares more about the access to a monastery than about the access to bank credit

If I had the right to vote I would have voted for Britain to stay in EU. But I would have hoped for that this option had won by just one vote, so that there was huge pressure on EU to clean up its act. It sorely needs it.

For instance, the European Commissioner for Internal Market and Services is in charge of promoting free movement of capital and therefore has a lot do to with the extremely important area of regulating the financial services. 

It is a topic of much interest for me since, for more than a decade, I have argued that the Basel Committee’s risk weighted capital requirements for banks, is impeding the free movement of capital with disastrous consequences for the real economy.

But in 2012, during a conference in Washington by the then Commissioner Michel Barnier, I was handed a brochure that presented, as a success story of his office, the following: 

“A French citizen complained about discriminatory entry fees for tourists to Romanian monasteries. The ticket price for non-Romanians was twice as high as that for Romanian citizens. As this policy was contrary to EU principles, the Romanian SOLVIT centre persuaded the church authorities to establish non-discriminatory entry fees for the monasteries. Solved within 9 weeks.” 

And then I knew for sure something smelled very rotten in the EU, with its full of hubris besserwisser not accountable to anyone technocrats.

How can they waste time on such small time discrimination when those borrowers ex ante perceived as risky, and who therefore already got less bank credit and at higher interest rates, now suffer additional discrimination caused by regulators requiring banks sot hold more capital when lending to them that when lending to those ex ante perceived as safe? And on top of it all, for absolutely no reason, since dangerous excessive bank exposures, are always built up with assets perceived as safe.

Barnier, as Frenchman should know Voltaire’s “May God defend me from my friends: I can defend myself from my enemies.” But now bank regulators tell banks “trust much more your friends”, the AAA rated, and to which in Basel II they assigned a risk weight of 20%; and “beware even more of your enemies”, the below BB- rated, and which were given a risk weight of 150%.

As a result banks can leverage more their equity with “safe” assets than with “risky” assets, and so they now earn higher risk adjusted returns on equity when lending to sovereigns, members of the AAArisktocracy or financing houses, than when lending to SMEs and entrepreneurs.

And as a direct consequence of this regulatory risk aversion, banks do not any longer finance the riskier future, they only refinance the for the short time being safer past.

So there is no wonder EU is not doing well. And if Brexit helps to push for the reform that are needed, then Britain should be given an open invitation to return to it at its leisure.

PS. During the Washington conference I just could not refrain from asking what the French citizen did for 9 weeks while waiting for SOLVIT to come to his rescue.

PS. Lubomir Zaoralek the minister of foreign affairs of the Czech Republic in FT “Europe’s institutions must share the blame forBrexit” July 1. Hear hear!