September 06, 2013

Risk-weighted capital requirements are a prime example of quack policies, and FT ignoring it, of quack journalism

Sir, Sir Samuel Brittan writes that “Politics resonate with the sound of quack policies”, September 6.

A prime example of those quack policies, are the risk-weighted capital requirements for banks based on perceived risk, lower-risk less-capital, higher-risk more-capital. These cause the banks to earn much much higher risk-adjusted returns on their equity when lending to “The Infallible”, the AAAristocracy, than when lending to “The Risky”, like the medium and small businesses, entrepreneurs and start-ups. And that of course distorts completely the allocation of bank credit to the real economy. 

Those capital requirements are not “based on evidence”, and do not stand up to scrutiny. As to the empirical evidence, this would point in the opposite direction, as all major bank crises have always resulted from excessive exposures to what is perceived as “absolutely safe”. As for the analysis that lies behind, that is as mumbo-jumboish as you can find.

Brittan holds that such quack policies “overlook the benefits that people derive from the discouraged activities”. Indeed the benefits for the real economy, of the banks providing access to “The Risky”, in competitive terms, are completely overlooked.

Brittan also hold that such quack policies ignore the substitutes that are found and can be as harmful as the original. Indeed, by allowing the banks to earn such high expected returns on equity on what is “absolutely safe”, they might lend it too much on too lenient terms, and so the safe havens can get get to be dangerously overcrowded, like what happened to AAA rated securities in the US, Spanish real estate, Greece and other “infallibles”.

But I must say that for the Financial Times to ignore such regulatory quack, for so long, even when I have written you over one thousand letters about the problem with these regulations, that could also classify as quack journalism.