September 19, 2014

What if instead of credit risks we used credit usefulness when weighing capital requirements for banks?

Sir, I refer to the opinions of several economists on how to jump-start wage growth… which of course has to do with the creation of jobs, “Pay Pressure” September 19.

Even though some of the economists asked by FT might have diddled a bit with bank regulations, I know at least Joseph Stiglitz has, economists in general have little knowledge of these, or, like Joseph Stiglitz, have not understood what the Basel Committee for Banking Supervision has been up to during the last decades.

The current pillar of bank regulations is the “risk weighted capital requirements”. And that, since the perceived credit risks are already cleared for in interest rates and the amounts of the loans, clears for the same risk perception a second time… something which distorts, and causes banks to lend too much to what is perceived as absolutely safe, and too little to what is perceived as risky, like SME’s and entrepreneurs.

I, also an economist, would prefer not to weigh any capital requirements for banks at all, applying the same percentage for all assets, as I believe markets distort less than economists and regulators. But, if regulators absolutely must weigh, in order to show they do something, I would implore them to instead of credit-risk ratings, use potential-of-job-creation ratings, sustainability-of-planet-earth ratings and, in the case of sovereigns, ethic-and-governability ratings.