Tuesday, October 15, 2013
If regulators absolutely must distort the credit allocation of banks, let it at least be for a good purpose
The risk-weighted capital requirements, the pillar of bank current bank regulations, Basel II and Basel III, more-risk-more-capital and less-risk-less-capital, are incredibly stupid and serve absolutely no purpose.
Incredibly stupid since just some little empirical research would evidence that all major bank crises, no exceptions, have resulted from excessive exposures to what was ex-ante perceived as “absolutely safe”, but which ex post turned out to be risky; and none ever has resulted from excessive exposures to what ex ante was perceived as “risky”. In fact more-risk-less-capital and less-risk-more-capital, totally the opposite, would have been more correct.
And they serve absolutely no purpose because, allowing banks to earn much much higher risk adjusted returns on their equity when financing “The Infallible”, than when financing “The Risky”, causes banks not to finance the “risky” future, and mostly dedicate themselves to refinance the “safer” past.
In my opinion, nothing can help to enable so much the financing of our two most urgent needs, the creation of sturdy jobs for the young, and the investment needed for the sustainability of our planet than more correctly aligned capital requirements for banks. First these should be set equal for all bank assets, for instance 8 percent, but then allowed to be lowered, gradually, down to 4 percent, depending on the potential-of –job-creation-ratings and/or sustainability ratings, like the SRI or ESG ratings mentioned, whether of the project or of the issuer, and the length of the contract.
That, as you can all understand, would allow the banks to earn the highest-risk adjusted returns where they can be the most helpful to the society.
PS. I carefully reviewed the whole EUROWEEK issue on Sustainable and Responsible Capital Markets, September 2013, and, unfortunately, though it includes many good discussions, I did not found a single word about the perceived risk weighted capital requirements.