November 05, 2012

More than simple rules we need rules that do not distort.

Sir, in your weekly review of the fund management industry, FTfm, Jonathan Davis writes that “There is an inevitable irony in the fact that the two main epicenters of the debt crisis, subprime mortgage lending and more recently sovereign debt, were both assigned minimal capital at risk ratings under the Basel II regime”, “Simple rules should trump regulatory overkill” November 5. 

“Irony”? No way José! The Basel II capital requirements for securities rated AAA, like those backed with mortgages to the subprime sector, and to sovereigns rated like Greece was for some years, were only a meager 1.6 percent of some very generously defined capital. If you allow banks to leverage the risk-adjusted return when lending to “The Infallibles” 62.5 times to 1, but only 12.5 times to 1 when lending to “The Risky”, that is simply dooming the banking system to a disaster. 

Of course, for all those reasons recently exposed by Andrew Haldane, we need simpler rules, but, what we most need is for the bank regulators to stop acting as if they were the master risk-managers of the world, and distorting the financial markets and impeding the banks from performing efficiently their vital function of allocating economic resources.