We urgently need our banks to be banks again
Current bank capital requirements, with capital meaning equity, meaning the skin in the game bank shareholders should have, are mostly based on perceived credit risks; not on misperceived risks, or the unexpected, like a Covid-19.
But they’re not! What’s perceived more creditworthy, meaning what’s preferred by banks, have much lower capital requirements than what’s perceived less creditworthy.
And lower capital requirements mean higher leverages, making it therefore easier to earn risk adjusted returns on equity with what’s perceived (or decreed by regulators) as safe, than with what’s perceived as risky.
The consequence? A
procyclicality that fosters higher and higher exposures to what’s safe, against less and less capital.
And what’s defined as “safe”? Loans to sovereigns, residential mortgages and assets with very high credit ratings?
And what’s risky? E.g., loans to small businesses and entrepreneurs.
So precisely like in 2007-08, when banks were caught with their pants down because of huge exposures to mortgage-backed securities with misperceived AAA ratings, they’re now standing there naked because of the unforeseen economic consequences of Covid-19; especially those derived from lockdowns.
The procyclicality of it all; when times are rosy banks can hold little capital but when times get hard banks have a hard time raising capital, sets us up to the fact
And so, just when we now most need banks to help us out, it’s the hardest for them to raise the capital that would allow them to do so. What a mess!
So, what would I propose? In few words, the following:
“Banks, you can now hold zero capital, but that comes with: zero dividends, zero buy-backs and zero bonuses until you have ten percent in capital against all assets; and until you’ve paid back, including a reasonable interest, all what central banks or taxpayers have assisted you with.”
To ease the transition one could allow all bank assets incorporated some months before the change, to be held, until its maturity, against the capital requirement valid when put on banks' balances.
And I would allow small investors to buy some of that bank equity that helps these meet that ten percent requirement on favorable conditions… so as to connect the banks with the citizens again
Fellow citizens, let’s rescue our banks from hands of those financial engineers concerned with “how much can we leverage this asset?”, so as to put these back into hands of loan officers whose first question to applicants is, “what are you going to use the money for?”
And let’s rescue banks from that statism/communism/fascism implied with risk weights of 0% the Government, 100% the citizens… all as if bureaucrats/politicians know better what to do with credit for which repayment they’re not personally responsible for, than e.g., entrepreneurs.
Let’s be clear. Risk taking is the oxygen of all development and so, in that vein, for the real economy what’s “safe” represents carbs, while what’s “risky”, proteins and vitamins.
Give it a thought, the newspaper you read; would it dare to publish a Galileo-heliocentric opinion and risk being confronted by the Basel Inquisition?
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