Banks need to be made more useful, meaning less distorted when allocating credit to the real economy

Sir, I refer to your “Banks should be made more solid” April 12.

Like you I welcome the introduction of the “leverage ratio” which will require banks to hold capital against assets, independently of perceived risk. And like you I am astonished banks could argue that a 5% leverage ratio, which in essence translates into an authorized 19 to 1 debt equity ratio, is too much for them… of course, arguing that a 3% leverage ratio, a 32 to 1 debt equity ratio is too much, blows anyone´s mind.

But, unfortunately, the regulators, as tyrannical experts, unable to admit to their mistakes, intend to keep in place a layer of risk-weighted capital requirements, and so the regulatory distortions will only continue.

I believe that much better for all, would be to make certain that a leverage ratio really applies to all assets, and abolish to just being bad memories, those risk-weighted capital requirements which only serve to amplify the negative consequences of insufficiently, and of excessively, perceived risks.

Of course, in the long term, once the real economy has recovered, regulators should try for banks to reach an 8% leverage ratio, that which is equivalent to the capital requirements established in Basel II for a 100% risk weighted asset.

As an aide memoire, the dangers the distortions in credit allocation produced by risk weighting are:

For the stability of the banking system, as it produces larger exposures than what should ordinarily exist, to what is erroneously perceived as “safe”, and then, when the real ex post risk reveals itself, banks stand there with less safety capital than what they ordinarily would have.

For the real economy, by causing many borrowers who are not perceived as that safe but who would ordinarily merit having access to bank credit, in competitive terms, to be denied it.