The risk weighted bank capital requirements had a real purpose... quite different from making our banks safe

"I have been sitting here for most of these five days without being able to detect a single formula or word indicating that growth and credits are also a function of bank regulations"

I've often complained about the lack of purpose of the current bank regulations… until I finally understood that the risk weighted bank capital requirements decreed weights of 0% government - 100% citizens, revealed their real purpose, the empowerment of Bureaucracy Autocracies.

And don't take my word for it. Paul Volcker valiantly confessed: “Assets for which bank capital requirements were nonexistent, were what had the most political support; sovereign credits. A ‘leverage ratio’ discouraged holdings of low-return government securities”

What would America’s Founding Fathers opine about bank capital/equity requirements with decreed risk weights: 0% Federal Government and 100% We the People?

Financial Communism

The Federal Reserve’s largest credibility problem is that it lost its independence

Sir, I refer to your editorial “The Federal Reserve has a credibility problem” Washington Post December 16, 2022

All you write there is sure important and correct. But yet, sadly, real peccata minuta when compared to the Fed losing its independence.

Paul Volcker in his 2018 “Keeping at it” (page 148) explaining the risk weighted bank capital requirements, that which allow banks to leverage more or less their equity (their skin-in-the-game) writes (confesses): 

“The assets assigned the lowest risk, for which bank capital requirements were therefore low or nonexistent, were those that had the most political support: sovereign credits and home mortgages… The American ‘overall leverage’ approach had a disadvantage as well in the eyes of shareholder and executives focused on return on capital; it seemed to discourage holdings of the safest assets, in particular low-return US government securities”

There with the “most political support”, the Fed clearly, if it ever had it, lost its independence.

What are American small businesses or entrepreneurs, those who because they are perceived as risky already get less credit and pay higher risk adjusted interest rates, to think of such regulatory subsidies handed out, in the Home of the Brave, to other “less-risky” access to bank credit competitors?

Volcker also states there: “Ironically, losses on those two types of assets would fuel the global crisis in 2008 and a subsequent European crisis in 2011”

He is wrong, it's not “ironically” but just a natural consequence. All larger bank crises have always resulted from excessive bank exposures built-up with assets perceived as safe, never ever with what’s perceived as risky.

My What Ifs on risk weighted bank capital requirements

“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… A ‘leverage ratio’ discouraged holdings of low-return government securities” Paul Volcker

"What If"... on risk weighted bank capital requirements

What if Basel Committee’s “Risk weighted bank capital requirements” had been labeled “Risk weighted bank equity/shareholders’-skin-in-the-game requirements”? Would the world have better understood the distortions caused?

What if one single Business School had questioned Basel Committee’s risk weighted bank capital requirements which imply bureaucrats know better what to do with credit, they’re not personally responsible for, than e.g., small businesses and entrepreneurs?

What if one single School of Economics had questioned Basel Committee’s risk weighted bank capital requirements which imply that residential mortgages are more important than e.g., small businesses and entrepreneurs?

What if one single statistician had explained to the Basel Committee that they might improve their risk weighted bank capital requirements by taking some lectures on conditional probabilities?

What if one single Nobel Prize winner in Economics had explained the dangerous procyclicality of the Basel Committee’s risk weighted bank capital requirements?

What if one Judge of the US Supreme court had questioned the constitutionality of risk weighted bank capital requirements with decreed weights: 0% Federal Government – 100% We the People? 

What if one renowned PhD had warned about the systemic risk introduced when, for purposes of risk weighted bank capital requirements, too much decision power was allocated to some few human fallible credit rating agencies?

What if one single renowned historian had reminded the Basel Committee that all major bank crises had resulted from excessive exposures built-up with assets perceived as safe, never with assets perceived as risky?

What if classifying government debt and residential mortgages as demand carbs; and loans to small businesses and entrepreneurs as supply proteins, would that have made a difference when deciding with what seeds our economies should be sowed?

What if instead of risk weighted bank capital requirements, we had purpose weighted bank capital requirements? Oops, what if the risk weighted bank capital requirements already concealed a purpose?

What if instead of besserwisser hubristic risk weighted bank capital requirements, we had a humble one single bank capital requirement against all assets?

Academia has kept total silence

PS. On this issue I’m not a newcomer.

PS. What to do? Here's a suggestion inspired by Chile.