Do you really think we can move forward discriminating in favor of “The Infallible” and against "The Risky"?

The kinder face of economic reality already favors the access to bank credit of “The Infallible”… lower interest rates, bigger loans and easier terms. 

And the harsher face of economic reality already disfavors the access to bank credit of “The Risky”…higher interest rates, smaller loans and stricter terms. 

But, when regulators allow banks to hold much less capital when lending to “The Infallible" than when lending to “The Risky”, then the banks will be able to earn a much higher risk-adjusted return on their equity lending to The Infallible than when lending to “The Risky”.

And so then “The Infallible” will be charged even lower interest rates, get even larger loans and on even easier terms, while “The Risky”, like our not-so-good rated or unrated small business and entrepreneurs, will be charged even higher interest rates, get even smaller loans and have to accept even stricter terms. 

And so let me ask you, do you really think this regulatory discrimination in favor of The Infallible and against The Risky makes an economic sense that might compensate for its injustice? I don’t, quite the opposite! 

It is outright foolish from an economic perspective, as it impedes banks to allocate our economic resources efficiently. And, to top it up, it brings more instability to the banking system because the bank exposures to what is ex-ante perceived as part of “The Infallible”, which are the only exposures that can set of a systemic crisis if ex-post these turn out to belong to “The Risky”, will not only be much higher but the banks will also be receiving the blows holding much less capital.

In truth bank regulators castrated our banks, and so these are all singing in falsetto now… and even badly so.

Frankly, between you and me, if I really thought the regulators had concocted these dumb regulations which are destroying our economies and causing so much suffering, knowingly and on purpose, I would consider that to be an act of high treason, and suggest they be shot, on the spot.

Bank regulators should learn about risk compensation and shared space philosophy.

Risk compensation, nothing to do with bonuses, is an effect whereby individual people may tend to adjust their behavior in response to perceived changes in risk. Individuals will behave less cautiously in situations where they feel "safer" or more protected. It is an argument that might help to explain the apparent paradox that reduced regulation leads to safer roads. 

The perceived risk of default in finance, functions like a natural traffic light. If the perceived risk for default of a borrower is high, the light red, banks lend less, at higher interest rates and on tougher terms. If the perceived risk for default of a borrower is low, the light green, banks lend more, at lower interest rates and on more lenient terms. 

The regulators though, with their capital requirements for banks based on perceived risks, by allowing for extraordinarily low capital requirements when the perceived risk were low, working like a collider, induced the banks to drive through the green lights much faster and with much lesser care, which resulted of course in this the mother of all financial pile-ups 

After a bank crisis characterized, as usual, by monstrously large exposures to what was officially considered as absolutely safe, like triple-A securities and infallible sovereigns, risk compensation is something our bank regulators should look into much more closely. 

According to the Shared-Space urban design philosophy, safety, congestion, economic vitality and other similar issues can be effectively tackled in streets and other public spaces by allowing traffic to be fully integrated with other human activity, not separated from it. Shared-Space streets have no traditional road markings, signs or traffic signals, and the distinction between "road" and "pavement" is blurred. The behavior of its users is more influenced and controlled by natural human interactions than by artificial regulation. 

Hans Monderman, 1945-2008, the Dutch traffic engineer known for his prominent role in the Shared-Space approach, was quoted saying: "We're losing our capacity for socially responsible behavior... The greater the number of prescriptions, the more people's sense of personal responsibility dwindles... When you don't exactly know who has right of way, you tend to seek eye contact with other road users... You automatically reduce your speed, you have contact with other people and you take greater care."

These days, when with their Basel III the regulators are digging our banks even deeper in the hole of excessive perceived safety, and we want and need our bankers to be better bankers and better citizens, we sure wish the Basel Committee would at least listen to some Shared-Space specialists.

PS. Risk-weighted capital requirements for banks, is also like allowing cars to go at different speeds depending on safety features, rated by "experts" and, of course, driven by fallible humans!!!