May 19, 2014

Europe cannot afford its banks not being able to lend to “the risky” because of bad capital regulations.

Sir, I refer to Wolfgang Münchau “Draghi has missed the chance to act on inflation” May 19.

When managing risks, before discussing risk avoidance, one need to clearly establish what risks one cannot afford not to take. And, in bank supervision, a risk one cannot afford to take is that of banks allocating credit inefficiently to the real economy.

But Europe, like other, thanks to dumb regulators, by means of capital requirements for banks based on ex ante perceived risk, has de facto dramatically increased the risk-aversion of its banks. And in these days of scarce bank capital, those poor bastards who have received a 100 percent risk-weight, like small and medium sized businesses, entrepreneurs and start-ups, those which as a group have always suffered the consequences of a financial crisis, but never caused it, are being increasingly locked out from access to bank credit.

In this respect ECB would be absolutely right in that it “may also encourage banks to lend money to small and medium sized businesses”, though the best way to do that would of course be for Mario Draghi and ECB to admit the regulatory mistake and get rid of the distortions produced by risk-weighting.

Frankly, when compared to the importance for Europe of their banks being able to take risks on “the risky” Münchau’s discussion on the consequences of having 1 or 2 percent inflation, sounds quite surrealistic to me.

PS. Again, you should not confuse the risk of dangerous large exposures to “the infallible” with the normally much safer as a group exposures to “the risky” paying high risk premiums.