More than about who sets the basic capital requirements for banks a sensible regulatory reform needs to worry about who sets the risk-weights.
Sir Howard Davies and David Green are correct suggesting that the setting of the capital requirements for banks should be placed in the hands of the monetary policy committee or whoever else sets the interest rate policy, as they are tools for a similar purpose, “Final touches for sensible regulatory reform” May 20. Currently that basic capital requirement decision is not even in the UK, having been delegated to the Basel Committee and which, for no special reason at all, seems to have carved out in stone an unmovable 8 percent.
But Davies and Green, much more than about the basic capital requirements, should worry about who takes the decisions on the risk-weights. It is those weights which really explain why, from mid 2000 until December 2009, the banks could lend to Greece with only 1.6 percent capital, while if they lent to any unrated UK entrepreneur they needed 8 percent in equity. This was because the Basel Committee, in Basel II, with precious little and quite dubious explanation, assigned a 20 percent risk weight for sovereigns rated A+ to A and corporate rated AAA to AA, while giving a 100 percent risk weight to any unrated clients. This arbitrary risk discrimination imposed on top of how the market already discriminates based on risk is the fundamental cause of this crisis, as it among others caused the stampede after triple-A rated investments.
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