The (Odious) Bank Credit Redistribution Act: The Great Financialization

1988 Basel I: Risk weighted bank capital requirements with decreed weights: 0% government, 50% residential mortgages and 100% the rest, e.g., small businesses and entrepreneurs; all as if bureaucrats know better what to with credit, for which repayment they’re not personally responsible for than e.g., small businesses and entrepreneurs; all as if financing the purchase of a house is more important than financing those who can create the jobs, the incomes, by which repay mortgages and service utilities.

Why? “Assets assigned the lowest risk, for which bank capital requirements were therefore nonexistent or low, were what had the most political support: sovereign credits & home mortgages” Paul Volcker

2004 Basel II: The introduction of the systemic risk of bank capital requirements depending hugely on human fallible credit rating agencies. To top it up the decreed weights e.g., 20% AAA to AA fated – 150% below BB- rated, continued to ignore the fact that all dangerous large bank exposures have always been built up with assets perceived as safe.

2007-2009 A global financial crisis (GFC) caused by excessive exposures to AAA rated mortgage-backed-securities (MBS).

2010 Basel III: Kicking the can forward so as not t be blamed the regulators, trying to mend regulatory blackholes concocted a mishmash of hundreds or regulations. Sadly, these all still leave intact, on the margin, which is where it most counts, the distortion in the allocation of credit produced by the risk weighted capital requirements.

2009… 2022: Job possibilities for bank supervisors and bank supervision responders keeps on booming… and just you wait for the ESG based capital requirements based on ESG ratings.

In short:

Bank capital requirements that so much favor government debts, has empowered Bureaucracy Autocracies all around the world. Central banks’ later Quantitative Easing (QEs), put that assistance on steroids

Before risk weighted bank capital requirements, bank credit was allocated based on risk adjusted interest rates. After, based on risk adjusted returns on required capital/equity (ROrE). That distorts even central banks’ monetary policy.

Bank capital requirements mostly based on perceived credit risks, not on misperceived risks or unexpected events, e.g., pandemic/war, guarantees banks will, sooner or later, stand there naked, just when we need them the most.

Favoring with much lower capital requirements banks holding “safe” government debt and residential mortgages (the present-demand-carbs), than loans to “risky” businesses (the future-supply-proteins), inflates inflation and causes obese - not muscular economic growth.

The Great Financialization, supported by low bank capital requirements, central banks’ QEs, and MMT preaching, produced way too much easy money... manna from heaven. That emptied many churches. Coming Minsky moments will fill these up again.

Extremely short:

These  risk weighted bank capital requirements have put Minsky moments on steroids.

PS. I have now, one way or another, been on this theme for twenty-five years