Basel I, II, and III are all examples of pure unabridged regulatory statism

In July 1988 the G10 approved the Basel Accord. For its risk weighted bank capital requirements it assigned the following risk weights:

0% to claims on central governments and central banks denominated in national currency and funded in that currency. 

100% to claims on the private sector.

That means banks can leverage much more whatever net margin a sovereign borrower offers than what it can leverage loans like to entrepreneurs. That means banks will find it easier to earn high risk adjusted returns on their equity lending to the sovereign than for instance when lending to entrepreneurs. That means it will lend too much at too low rates to the sovereign and too little at too high rates to entrepreneurs.

In other words Basel I introduced pure and unabridged statism into our bank regulations. 

Basel II of June 2004 in its Standardized Risk Weight, for the same credit ratings, also set lower risk weights for claims on sovereigns than for claims on corporates.

In a letter published by FT November 2004 I asked: “How many Basel propositions will it take before they start realizing the damage they are doing by favoring so much bank lending to the public sector. In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits.”

And the European Commission, I do not know when, to top it up, assigned a Sovereign Debt Privilege of a 0% risk weight to all Eurozone sovereigns, even when these de facto do not take on debt in a national printable currency.

And, to top it up, the ECB launched its Quantitative Easing programs, QEs, purchasing European sovereign debts.

At the end of the day, the difference between the interest rates on sovereign debt that would exist in the absence of regulatory subsidies and central bank purchases, and the current ultra low or even negative rates, is just a non-transparent tax, paid by those who save. Financial communism

And all this began one year before the fall of the Berlin Wall

30 years after the introduction of risk weighted capital requirements for banks, the European Commission's Action Plan, finally spills the beans on that these can distort the allocation of bank credit, for a good (or for a bad) purpose.

The European Commission's Action Plan for a greener and cleaner economy, of March 8, 2018 includes the following statement:

“Incorporating sustainability in prudential requirements: banks and insurance companies are an important source of external finance for the European economy. The Commission will explore the feasibility of recalibrating capital requirements for banks (the so-called green supporting factor) for sustainable investments, when it is justified from a risk perspective, while ensuring that financial stability is safeguarded.”

To my knowledge this is the first time in 30 years, since the introduction in 1988 of risk weighted capital requirements for banks, that an official entity has recognized that by distorting the allocation of bank credit, in favor or against something, regulators can make banks serve a purpose different from safeguarding financial stability.

PS. Sadly though not even “safeguarding financial stability” was well served as all this regulation did was to doom banks to dangerously overpopulate safe-havens holding especially little capital

PS. In October 2013 I discussed this issue on my "Our-piead-a-terre blog"

PS. And on Earth Day 2015 I made a proposal exactly like what the EC will now study, namely to base the capital requirements for banks based on the Sustainable Development Goals SDGs, which of course include environmental sustainability.

@PerKurowski

Are bank regulators violating human rights with their perceived-credit-risk obsession?

It is not only the suffering bank regulators have caused, and cause, but also that their regulations, especially in Europe, amounts to intellectual torture… pure waterboarding. Listen to this:

Bank regulators ask (instructs) the credit rating agencies: “Go out there and do a perfect credit rating job”.

And logically the banks will consider those perfect credit ratings in order to set their interest rates, and decide on the amount of their exposure to the credit risks indicated by those ratings.

But then the regulators also require the banks to hold capital (equity), based on the same perfect credit ratings.

That is because even though regulators knew that capital is to be required against unexpected losses, since they faced difficulties in calculating the unexpected, they decided to base it on the expected credit losses.

And, if you give an excessive consideration to a perfect credit rating, then of course the resulting credit decision will be wrong.

And so now, for these capital requirements to be able to allocate bank credit correctly to the real economy, the credit ratings need to be adequately wrong. What is perceived as safe must be much safer, and what is perceived as risky must be much riskier.

And of course, who has ever heard of a major bank crisis that resulted from banks lending too much to what they perceived as risky?

And with this dangerous regulatory nonsense: more perceived credit risk more capital – less perceived credit risk less capital, regulators allow banks to leverage their equity (and the support they receive from taxpayers) much more when lending to The Safe than when lending to The Risky; and which meant banks earn higher risk-adjusted returns on equity when lending to The Safe than when lending to The Risky; which means banks will lend too much to The Safe and too little to The Risky.

And so a monstrous financial crisis resulted… as always, from excessive financial exposures to what was perceived a safe, but in this case aggravated by the fact that banks, thanks to the regulators, stood there naked with especially little capital to cover themselves up with. And the resulting human sufferings are huge.

And so our banking system, because of its regulators' obsessive credit-risk aversion, also negates the future generations that kind of risk taking that helped the current one to be where it is. And so the resulting human sufferings will be huge.

And because now, years later, some regulators discovered that their risk weights might have impeded the fair access to bank credit of the “risky” SMEs… they now, magnanimously, decided that: “Capital charges for exposures to SMEs should be reduced through the application of a supporting factor equal to 0,7619 to allow credit institutions to increase lending to SMEs.”… 0,7619? Why not 0,7618? Why not 0,0001? At least for the small and micro, those with less than 50 employees… when have excessive bank loans to these “risky” ever created a financial crisis?

Please Basel Committee, please Financial Stability Board, and please European Commission, no more waterboarding… I can’t stand it more… my head, and my heart, hurts… what do you want me to do? What do you want me to confess?

The Basel Committee for Banking Supervision flagrantly violates the precautionary principle by turning a blind eye to the dangers.

The precautionary principle states that if an action or policy has a suspected risk of causing harm to the public or to the environment, in the absence of scientific consensus that the action or policy is not harmful, the burden of proof that it is not harmful falls on those taking an action.

I have for years denounced that the credit-risk weighted capital requirements for banks adopted by the Basel Accord as the pillar of their regulations seriously distort the allocation of bank credit to the real economy.

The consequences of too much bank credit to what is perceived as “safe” and too little credit to what is perceived is that banks do not any longer finance the risky future, our children and grandchildren need to be financed, but only refinance the safer past. With this the world is slowly but surely coming to a grinding halt.

But the Basel Committee, the Financial Stability Board, the European Commission on Banking and Finance, IMF, BIS, ECB, Fed, FDIC, BoE and all other relevant institutions just look away and do not want that issue discussed.

It sure is a flagrant violation of the precautionary principle that will cause immense damage. 

Please… help me break the silence of that irresponsible mutual admiration club!

You bank regulators... get your priorities right, urgently, or we depict you on some shame poles.

Very few of us like having banks "too big to fail" or bankers receiving exaggerated bonuses. 

But, if banks are “too big to fail” and bonuses to bankers seem immorally large, but our banks still do a good job allocating economic resources efficiently, that is hard, but still quite livable. 

But if banks do not allocate economic resources efficiently, then even if all our banks are small, and easy to liquidate, and all our bankers do not receive more compensation than anyone else, that is still, something completely unacceptable. 

So please, European Parliament, European Commission, Basel Committee, Financial Stability Board, Michel Barnier, Stefan Ingves, Mario Draghi, Mark Carney, Lord Turner, Ben Bernanke… get your priorities right! 

The way YOU allow banks to hold lower capital against exposures considered as risky, than for exposures considered as safe, and which allows banks to earn higher expected risk-adjusted returns on what is perceived as safe than on what is perceived as risky, is bloody murdering the economies of the Western World, those economies which became prosperous thanks to a lot of risk-taking. 

When I think of all those opportunities missed, forever, to generate good jobs for our youth, only because of your regulations, I tell you I would have no qualms whatsoever depicting you on some shame poles, and placing these totems all around the most public places in Europe and America.