September 25, 2012

The eurozone might be better off fixing its banks the Chilean way

Sir, it is completely counterproductive for the economy if banks can comply with harsher capital requirements by switching to holding assets which require less capital. That is an aspect amiss in Philipp Hildebrand´s and Lee Sachs' “The eurozone should fix its banks in the US way". September 25. 

To have the ECB propose purchasing bank equity in order to blackmail private investor into increasing their bank equity while Basel II or III´s discrimination based on perceived risk is still in effect, does simply not work. 

Set instead a fix capital ratio for any asset, like 8 percent, for loans to infallible sovereigns the same as for loans small businesses, and then you will get some real action. 

If that would require too much capital then perhaps ECB, and Europe, could benefit from doing something along the way Chile did during its monstrously large bank crisis 1981-1983. Excluding for some foreign exchange considerations, those Chilean actions were in summary based on: 

a. The purchase of risky loans by the Central Bank by means of long term promissory notes accruing real interest rates and with a repurchase obligation out of the profits of the banks' shareholders before that promissory note came due. out of there and some limitations on the use of operative income. 

b. There was a forced recapitalization of the banks and in which any shares not purchased by current shareholders, would be acquired by the Central Bank, and resold over a determined number of years. 

c. And finally there was also an extremely generous long term plan for small investors to purchase equity of banks. 

The above, together with some strong revisions of bank regulations, helped to set Chile on a track that Europe would currently envy.