December 16, 2015

COP21: Bank capital requirements based on sustainability and job-creating ratings would have been a major step forward

Sir, Martin Wolf commenting on the Paris COP21 agreement on limiting the risks of climate change writes “The provision of needed finance is an aspiration, not a bankable commitment” “One small step forward for humankind” December 16.

Indeed, sadly the agreement missed something I have been proposing for quite some time.

Our banks, one of our most important agents to bring us forward, have been told by their regulators that if they hold assets perceived as safe from a credit point of view, they will be allowed to leverage their equity and the support they receive from society much more than if they hold assets perceived as risky.

Since bankers with interest rates and size of exposures already clear for credit risks, it is quite nutty to require that perceived risk to be cleared for again in the capital.

The net result of it is permitting banks to earn higher risk adjusted returns on equity when financing the safe than when financing the risky. And expected credit risk is an expected credit risk that should be managed by the banks if they want to stay open, and has not one iota to do with whether a borrower has something that is worthy to be financed.

In general terms, and since it requires hubris, I am opposed to any type of distortion of bank credit allocation to the real economy. But, if I had to distort, I would only do that in pursuit of a good purpose, like helping the sustainability of our planet and creating jobs for our youth.

I am absolutely sure that if COP21, in Paris, had come up with an agreement that instructed bank regulators to forget credit ratings and use sustainability and job creation ratings to set the capital requirements for banks instead – more sustainability and more job creation less equity and therefore higher ROE - then Wolf could have written about “A major step forward for humankind”

Of course that would have required explaining how purposeless and useless current bank regulations are, and there are many who do not want that to be understood. Regulators because they might be held accountable, bankers because that would signify having to give up a dream come true, making their big profits on what they think (or can make out to be) safe.

@PerKurowski ©