February 07, 2016

Tim Harford. Avoiding the risky and embracing the safe, is that a good New Year resolution for banks at the Basel gym?

Sir, Tim Harford, a self-declared undercover economist, writes about incentives in “How to keep your gym habit” February 6. It is very interesting but, as an economist writing for FT, he should perhaps be more interested in the incentives that guide the actions of our banks.

The regulators, by means of risk weighted capital requirements; which allow banks to leverage more with assets perceived or deemed safe than with assets perceived risky; which allow banks to earn higher expected risk adjusted returns on equity with assets perceived or deemed as safe than with assets perceived as risky; have created great incentives for banks to stay away from what’s “risky”, like the SMEs and entrepreneurs, and to embrace what’s “safe” like sovereigns, the AAArisktocracy and housing.

To me, also an economist, that would, in terms of a gym, indicate incentives for banks to stay away from anything that could break out a sweat; and in terms of a diet, to stick with chocolate cake and forget the spinach.

Short term everyone but “the risky” can love it; higher expected risk adjusted profits on what’s safe than on what’s risky sounds like a banker's wet dream. But, in the not so long run, that is clearly unsustainable and will cause a dangerous increase of obesity among banks and in the real economy. 

And so, in the particular case of banks, it is not that the incentives don’t work, it is the New Year resolution imposed on banks by the Basel Committee that is plain wrong.

@PerKurowski ©