Any risk, even if perfectly perceived, causes the wrong answer to it, if excessively considered.
Any risk, even if perfectly perceived, causes the wrong action, if excessively considered.
“A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it looks to rain” Mark Twain (supposedly)
And Mark Twain is right in that bankers, in general are risk adverse and, when they accept taking some, it is usually in small amounts and against high risk premiums.
And, for around 600 years, bank credit was allocated, usually with a view on the portfolio, based on risk adjusted net interest rates.
But then, in 1988 with Basel I, the Basel Committee introduced (I would say ‘concocted’ is a more precise term) the concept of risk weighted bank capital requirements, based on exactly the same credit risk aversion.
With that the regulators ignored that any risk, even if perfectly perceived, causes the wrong answer to it, if excessively considered.
If Twain was alive he could just as well be writing: “A bank regulator is a fellow that allow banks to hold little capital when the sun is shining, so that banks can pay lots of dividends and buy back lots of stock, but wants banks to hold much more capital, the moment it starts to rain”
And, since then, bank credit is allocated based on risk adjusted returns on equity and, of course, the higher the allowed leverage is the easier it is to obtain a higher return on equity.
John A. Shedd (1859 – 1928) wrote “A ship in harbor is safe, but that is not what ships are for”. And that should also apply to banks. Unfortunately, these capital requirements guarantee that banks stay in safe harbors, running the risk of dangerously overcrowding these, and stay away from the risky oceans, and most certainly not lending enough to those “risky” entrepreneurs and SMEs on which our real economies so much depend.
In his book “Money: Whence it came, where it went” (1975), John Kenneth Galbraith wrote “The function of credit in a simple society is, in fact, remarkably egalitarian. It allows the man with energy and no money to participate in the economy more or less on a par with the man who has capital of his own. And the more casual the conditions under which credit is granted and hence the more impecunious those accommodated, the more egalitarian credit is”
By doubling up on credit risk, the regulators made it so much more difficult for banks to fulfill such important societal function.
And it’s all so much worse. With their much lower bank capital requirements on loans to governments than on loans to citizens, statist/communist/ fascist regulators de facto imply bureaucrats/politicians know better what to do with credit for which repayment they’re not personally responsible for, than e.g. entrepreneurs.
And it is all so stupid. There’s never ever been a major bank crisis caused by the buildup of excessive exposures to what’s perceived as risky, those exposures have always been built up with assets perceived as safe.
The regulators, by basing most of their pro-cyclical bank capital requirements on perceived credit risks; not on misperceived credit risks, or unexpected dangers, like a pandemic, guaranteed all banks now stand there with their pants down. Basel Committee, Good Job!
Posts
