Friday, September 12, 2014

Are bank regulators too dumb or too irresponsible… or too much both things?

We have bank regulator who seem to have decided that their role is to make banks safe, even if they have to take the real economy down. And that means that they are either too dumb, or too irresponsible, or too much both things.

By imposing capital (equity) requirements for banks based on the ex ante perceived credit risk of borrowers, and making these much much smaller when lending to those perceived as “absolutely safe” than when lending to those perceived as “risky”, regulators allow banks to earn much much higher risk-adjusted returns on equity when lending to the “absolutely safe” than when lending to the “risky”.

And that means banks will lend much too much to those perceived as “absolutely safe”, to such an extent that more sooner than later some of these will turn into very risky and could implode the banks; and much too little to those perceived as "risky", those which include medium and small businesses, entrepreneurs and start up, which will make the economy stall and fall.
  
And we are not talking peanuts here. In Basel II, though when lending to the risky they required banks to hold 8% in capital (equity), they allowed banks to lend to someone of the AAAristocracy holding only 1.6% in capital. That means banks could leverage their equity a generous but still reasonable 12.5 times to 1 when lending to the risky, and were allowed to leverage a truly mindboggling 62.5 times to 1 lending to the “absolutely safe”. And, when lending to “infallible sovereigns”,  the banks needed to hold no capital at all, and so not even the sky was the limit on allowed leverage.

Allowing banks to lend to Greece leveraging their equity 62.5 times? And of course Greece got too much loans.

Allowing banks to earn more on what is perceived safe than on what is perceived risky? And of course the tough risky risk-takers we need to get going when times are tough, will not get the loans they need, and so jobs will not be created and many of our kids doomed to become part of a lost generation.

“Oh but they have rectified in the new Basel III” I hear you say. Forget it! Pure propaganda, in many ways they have only made it worse... they are only digging us deeper into the hole.

And so now you tell me… are bank regulators too dumb or too irresponsible or, as I believe, much too much of both things?

But, we citizens are not too bright either, allowing some regulators who we do not know, to concoct their potions, in splendid isolation in their mutual admiration clubs of the Basel Committee for Banking Supervision and the Financial Stability Board, and without holding them accountable for what they do.

Friends, were we to tackle the challenge of climate change in a similar way, I assure you our planet earth... would be toast.