If you want your nation to prosper and become strong, what bank capital (equity) requirements would you prefer?

The current risk weighted ones, which have banks allocating their credit based on risk adjusted return on required equity (ROrE)? 

These imply e.g.:

Bureaucrats knowing better what to do with credit for which repayment they’re not personally responsible, for than small businesses and entrepreneurs.

Financing the purchase of houses with residential mortgages has priority over financing those who can create the jobs, the incomes, by which repay mortgages and service utilities. (Which makes houses become more investment assets than affordable homes)

Or, just one single capital requirement against ALL assets, a leverage ratio, which will have everyone compete for credit with risk adjusted interest rates, and banks allocating their assets based on maximizing their risk adjusted return on one single equity (ROE)?

Or, would you argue: “But, the risk weighted makes our bank system safer”  Sorry, No! It’s just another dangerous Maginot Line

The first nation to kick out Basel Committee regulations and return to one single bank capital requirement against all assets, has the best chance of getting back on the right track. How to transition from here to there? Not easy, but here’s one route.

PS. Why do those who with so much emotions argue against trade protectionism, with such ease ignore to argue against credit allocation protectionism?

A tweet to @imfcapdev April 5 2021

"Excess of carbs e.g., government loans, residential mortgages; insufficient proteins e.g., bank loans to entrepreneurs and lack of exercise e.g., no creative destruction/zombification, causes GDP obesity. Can IMF/WBG develop a Body Mass Index for GDP?"

If you go into that dark forest that looks horrible to you... then we will force you to eat broccoli and spinach.

But if you stay out on the fields where everything looks safe and beautiful... then we will allow you to eat as much chocolate cake and ice cream you want.

Here my dialogues with #AI ChatGPT - OpenAI about current bank capital/equity requirements.

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

And the Academia kept silence.

Note: The Basel Committee’s use of the term “capital” in “risk weighted bank capital requirements” has sowed loads of confusions. Its real significance is “risk weighted bank shareholders’ equity/skin-in-the-game requirements". It has nothing to do with in what bank assets it’s invested.

“A ship in harbor is safe, but that is not what ships are for”. John A. Shedd, 1928. Does that not apply for banks too?

For about 600 years banks allocated credit based on risk adjusted interest rates. After risk weighted capital requirements were introduced, they allocate it based on risk adjusted returns on regulatory equity (RORE). Huge distortions ensued! 

And the Academia kept silence.

The risk weighted bank capital requirements are based on perceived credit risks and not on risks conditioned to how bankers react to perceived risks. Clearly the regulators know nothing about conditional probabilities.

And the Academia kept silence.

To delegate so much of the determination of credit risk into the hands of some few human fallible credit rating agencies, had, almost by definition, to introduce into our banking systems, a dangerous systemic risk.
And the Academia kept silence.

Lower bank capital requirements when lending to the government than when lending to citizens, de facto implies bureaucrats know better what to do with credit they’re not personally responsible for than e.g. entrepreneurs

And the Academia kept silence.

Lower bank capital requirements for banks when financing the central government than when financing local governments, de facto implies federal bureaucrats know much better what to do with credit than local bureaucrats.

And the Academia kept silence.

Lower bank capital requirements for banks when financing residential mortgages, de facto implies that those buying a house are more important for the economy than, e.g. small businesses and entrepreneurs.

And the Academia kept silence.

Lower bank capital requirements for banks when refinancing the “safer” present than when financing the “riskier” future, de facto implies placing a reverse mortgage on the current economy and giving up on our grandchildren’s future.

And the Academia kept silence.

When outlook is rosy, investment grade abounds, banks can: hold little capital, leverage a lot, obtain high returns on equity, buy back lots of shares, pay lots of dividends and huge bonuses. When rain starts, junk grades appear… banks will stand naked.
And the Academia kept silence.

And all for nothing. Those excessive bank exposures that could be dangerous to our bank systems are always built-up with assets perceived or decreed as safe, and never ever with assets perceived as risky.

And the Academia kept silence.

Could it be that? “One has to belong to the intelligentsia to believe things like that: no ordinary man could be such a fool.” George Orwell

The statist confession that shall not be heard

“Assets for which capital requirements were nonexistent, were what had most political support: sovereign credits. A simple ‘leverage ratio’ discouraged holdings of low-return government securities" Paul Volcker

And in the USA those risk weighted bank capital requirements seem to be unconstitutional

On the Nobel Prize: The Economic Sciences Prize Committee of the Royal Swedish Academy of Sciences selects the Nobel prize winner in economic sciences. That prize was established by Sveriges Riksbank in 1968. The current Governor of said central bank, is Stefan Ingves who, from 2011 until 2019, served as the Chairman of the Basel Committee on Banking Supervision.

https://subprimeregulations.blogspot.com/2025/12/ai-chatgpt-grok-does-basel-committees.html

Could anyone arguing that what’s perceived as safe is much more dangerous to our bank system (heliocentric) than what’s perceived as risky (geocentric), be nominated for that prize by such a (Inquisition) committee? 

https://subprimeregulations.blogspot.com/2020/12/how-come-we-ended-up-with-stupid.html

PS: With the appearance ChatGPT – Grok, Academia will be asked much more on the why of its almost total silence on the outright dangerous bank regulations. Just wait until their peer reviewed papers get reviewed by #AI.

https://subprimeregulations.blogspot.com/2023/06/my-questions-to-ChatGPT-Grok-about.html

Since we know all about risks, to make your banks safe, we regulators, we the Basel Committee, we give you our risk weighted bank capital requirements. And the Academia (desperately wanting to be counted among the Pigs on Orwell’s farm) kept silence.

http://perkurowski.blogspot.com/2023/05/has-orwells-big-brother-already.html