September 12, 2011

The Vickers Report, like the Basel regulations, would benefit from defining the purpose of banks.

The current crisis was caused, almost entirely, by regulators arbitrarily setting risk-weights which allowed banks to lend or invest in sovereigns and what was triple-A rated with truly minuscule capital, 1.6 percent or less. As the Vickers Report keeps the notion of capital requirements based on risk-weighted assets, it does not protect against what it needs to protect.

Here is a question that I dare John Vickers and his colleagues to answer. Why should banks be allowed to leverage their capital more when earning their risk-adjusted-interest-rates from what ex-ante is perceived as the “not-risky”, than when earning these from the “risky”? Does that not mean that the “risky”, like the job creating small business or entrepreneurs, will then need to pay the banks higher interest rates than would otherwise have been the case without regulatory intervention? Or vice-versa that the “not-risky” will benefit from lower interest rates than the market rates? 

It is high time to stop thinking in terms of “buttressing the banks” and start thinking in terms of “buttressing the role of banks in the economy” For instance, is not the risk of an economy without jobs for our youth much riskier than having some banks failing?