Real banking reform will only happen when regulators understand and acknowledge what they did wrong, and correct it.

Sir, Martin Arnold writes “Regulators are forcing banks to hold much more capital and to reduce their leverage, which is making some areas of business unprofitable. This is pushing some banks to quit those areas”, “Bankers assess once-in-generation reform” January 24.

That is indeed one way to word it, but since the truth is that the profitability of these areas was artificial in that it was based on the fact that they required much less capital than other, there should hopefully be other areas which could regain competitive profitability… like lending to medium and small businesses, entrepreneurs and startups.

The real reforms of banking will, sooner or later, only come when regulators understand and acknowledge the following:

You can´t have capital requirements for banks that are “portfolio invariant”, namely those which do not consider the benefits from a diversification of assets in “the risky” category, or the dangers of excessive concentration of assets to “the infallible”.

The fact that an asset is deemed risky because it has high "expected losses", does not mean one iota that it has the potential of more “unexpected losses”, which is what capital is there for, than what is perceived as “absolutely safe”.

That the efficient allocation of bank credit to the real economy is, medium and long term, of much more significance for the real safety of banks, than what can be achieved by any distorting risk management carried out by regulators-

Unfortunately, before the above is fully realized, things could get much worse.