December 02, 2013

When the autopsy on Europe’s economy is performed, the cause of death will be sissy and dumb bank regulatory risk aversion.

Sir, Wolfgang Münchau writes “Lending by banks to the private sector is contracting at accelerated rates… Unsurprisingly the banks are trying to minimize the amount of capital they need to raise by scaling back their risky exposures to private creditors.” “Germany’s coalition will have to break promises”, December 2. And then he writes that “It is rational to expect the credit crunch to continue for as long the adjustment in the banking sector takes place – all the way through to 2014.

Yes, “unsurprisingly” and “rational” are the correct terms, but they are related to the completely irrational capital requirements for banks based on perceived risks.

Before these regulations came into being a bank looked at how to maximize the return of each euro by lending all over the spectrum of perceived risks… and that is what can lead to an efficient allocation of bank credit in the real economy.

Not now. Now a banks looks at the risks of an AAA rated, and since its regulatory risk weight is 20 percent, it uses only 20 percent of a euro when comparing its return to the return of a loan to a “risky” small business, and for which it has to use the full 100 percent of a euro. And, if lending to an “infallible sovereign”, then it can basically measure its returns on equity use 0 percent of a euro as equity.

No! When the autopsy on Europe’s economy will be performed some years from now, these loony and sissy risk adverse regulation virus is going to be identified as the prime cause of its death, and FT and its journalist, by having kept mum on it, will be among its contagion agents.