July 21, 2011

The “risky” must unite! Their risk-adjusted dollars should be worth just as much as others.

Sir, Joseph Stiglitz, in “Now the central bank must act” July 21, makes a reference to “risk-adjusted interest rate”. That is good. I thought our 2001 Nobel Prize winner might have no idea of such concept. And I say that because of the following. 

Stiglitz was the Chair of The Commission of Experts of the President of the UN General Assembly on Reforms of the International Monetary and Financial System. That Commission in its report of September 2009 and though finding that “Regulators need to be aware of distortions in capital allocation when provisioning and capital adequacy requirements do not accord well with actuarial risks”, fails to point out with sufficient clarity the odious and arbitrary discrimination present in bank regulations. 

According to Basel II, when $1 in risk adjusted interest rate is paid by highly rated sovereigns or a triple-A rated client, it can be leveraged on bank equity 62.5 to 1, while the same $1 in risk adjusted interest rate, when paid by less well rated sovereigns or “risky” small businesses and entrepreneurs, is only authorized to leverage bank equity 12.5 times to 1. It is inexplicable that regulators could find some risk adjusted interest rates are five times as good as others. 

The consequences of such regulatory madness, something which by the way is still going on, is to drive the banks excessively into the arms of what is ex-ante perceived as not-risky and away from what is perceived as risky; and that is why banks have drowned in exposure to triple-A rated instruments and “strong” sovereigns, and that is why bank lending to not so well rated sovereigns, small businesses and entrepreneurs, is either drying up completely or has to be done with much higher compensating interest rates. And that is plain crazy! 

The “risky” must unite! Their risk-adjusted dollars should be worth just as much as others’. 

PS. Loony bank regulations explained in an apolitical red and blue! http://bit.ly/mQIHoi