The standardized risk-weights of Basel II, provided the coverage banks needed to hold minimum capital

Sir, your “In praise of bank leverage ratios”, July 11, though I agree with its title, just shows how little you have understood about the underlying causes of the North Atlantic banking crisis.

You write “rather than imposing standardized risk weight, regulators have let banks use their own model. This undermines the credibility of the exercise.”

The standardized weight in Basel II, for holding for instance the AAA rated securities backed with mortgages to the subprime sector in the USA, or loans to Greece, was only 20 percent; which signified that banks could hold these assets against only 1.6 percent in capital; which meant banks could leverage their equity 62.5 to 1 with these assets.

In fact, without the guidance of these standardized weights, the banks would not even have dared to convince their regulators that so little capital could be needed.

Since you also hold that the leverage ratios needs to be combined with effective risk-weighted capital ratios, you also show not having understood how these distort when it comes to banks allocating credit to the real economy.

But, with respect to that macroprudential policy should be counter-cyclical, on that we agree completely, as I indicated in a letter to you in 2004.

Nonetheless most of this discussion will be a moot point in January 2015. The Basel Committee has instructed the banks to report their leverage ratio from that day on. And after all recent signs of “bank creditors, caveat emptor, you won’t be bailed out like before”, like in Cyprus, banks have to be truly insane not knowing they have to substantially raise their capital, in order to survive the coming stampede from banks leveraged over 30 to 1 to those leveraged 10 to 1, no matter the riskiness of the underlying assets.

And the USA, thanks to FDIC, is taking the lead lowering those ratios. Europe, beware!