Do the risk weighted bank capital requirements make the risky more or less risky?

Basel III’s bank capital requirement’s risk weights (RW) for residential mortgages depending on Loan to Value (LTV); implied Allowed Leverage of capital/equity (AL) and expected Return On Equity (eROE), calculated with a Risk Adjusted 0.5% expected Return on Asset (eROE) 

LTV<50%: RW = 20%: AL = 62.5 to 1: eROE = 31%

50% < LTV ≤ 60%: RW = 25%: AL = 50 to 1: eROE = 25%

60% < LTV ≤ 80%: RW = 30%: AL = 41.7 to 1:  eROE = 21%

80% < LTV ≤ 90%: RW = 40%: AL 31.25 to 1: eROE = 16%

90% < LTV ≤ 100%: RW = 50%: AL 25 to 1: eROE = 12%

LTV > 100%: RW = 70%: AL 17.9 to 1: eROE = 9%

Those with higher LTV, because they are riskier, must naturally pay banks higher risk adjusted interest rates. But, since banks can hold less capital against lower LTVs, they must also compensate banks, so as to provide these with a competitive risk adjusted return on equity.

So, in order for those who have no money to put down (LTV) > 100%, and with which banks can leverage 17.9 times, in order to compete with those who put down LTV <50%, need to provide an expected Risk Adjusted Return on Asset of 1.73 (31%/17.9); meaning in this case a 1.23% higher interest rate than without this distortion.

And we ask: charging those who have no money to put down, and who should perhaps not even have access to a residential mortgage, a 1.23% higher interest rate than what their risk adjusted interest rate would otherwise be, does that make these more or less risky?

Conclusion: The risk weighted bank capital requirements have, de facto, 0% to do with credit risk reduction, and 100% to do with risk generating distortions.

If race can be correlated to higher LTV mortgages, does this not de facto imply regulators are engaged in discrimination based on race?

Basel Committee... Good Job!

In that real very real class war between those who have houses as investment assets and those who just want affordable homes, where do you stand?

Being more creditworthy should not mean being more worthy of credit

And we must also ask, are the risk weighted bank capital requirements really in accordance with the spirit of the Equal Credit Opportunity Act (ECOA) or the Community Reinvestment Act (CRA)?

The risk weights are to access to credit, what protectionist tariffs are to trade, only more pernicious.

Why has Academia for decades kept silence on Basel Committee’s loony and dangerous risk weighted bank capital requirements?

My 2019 letter to the Financial Stability Board (FSB)

Educating Martin Wolf (and others in dire need of it): Stupid Bank Regulations 101

When banks are allowed to hold less capital against assets perceived ex-ante as “not risky” the regulators are effectively discriminating against banks holding assets ex-ante perceived as “risky”, like loans to small businesses or entrepreneurs. 

And that amounts to a distortion of the market. The direct effects of that distortion is that those perceived as not risky will have an ampler and cheaper access to bank credit than what would have been the case without these regulations, and those perceived as “risky”, will have a scarcer and more expensive access to bank credit that would have been the case without these regulations.

In other words, it signifies a regulatory subsidy to those already benefitted by the market and banks from being perceived as “not risky”, and a regulatory tax on those already being taxed by the market and banks because they are perceived as "risky".

In other words we´ve got ourselves a much ignored class-war carried out under the cover of bank regulations by the "not risky" against the "risky".

And that discrimination against what is perceived as risky, must of course negatively impact the economy and the creation of jobs, which both thrive precisely based on the risk-taking. 

And all for no good purpose at all, because never ever has a major bank crisis resulted from excessive exposures to what was ex ante perceived as risky. 

And all that regulatory nonsense, or even worse than nonsense, is a direct result of not specifying clearly what the purpose of our banks is. Surely it cannot be to survive in an economy where everything else fails.

And, if regulators absolutely must interfere, because it is in their nature, then why don´t they do it with a purpose, and for instance set the capital requirements for banks based on potential-for-jobs-for-youth ratings?

And, if regulators absolutely must interfere, and must to do so based on perceived risks then why not do so based on how bankers react to perceived risk. Although in that case it would seem that the capital requirements for banks should be higher for any asset perceived as “absolutely not-risky” and lower for any asset perceived as “risky”.

Also as is, no one has any idea of what the real market interest rates are. For instance what would be the UK Treasury rate if banks needed to hold as much capital when lending to the UK Treasury, than when lending to a UK citizen? 

Research assignment (choose one of the two) 

1. Make a regression between the major problem assets during the crisis and the low capital requirements for holding those assets, and then explain what inferences can be drawn from the results. 

2. Investigate who could have authorized bank regulators to award subsidies on access to bank credit to the “not-risky” or tax the access to bank credit of the “risky”. Alternatively you could investigate who could have authorized bank regulators to earn more, by means on higher leverage, when lending to the “not-risky” than when lending to the “risky”.

PS. There will be a quiz on this soon