June 13, 2016

Basel Accord’s risk weights subsidized sovereign bonds, so since then these were no longer proxies for risk free rates

Sir, Michala Marcusssen argues that because of quantitative easing and negative interests “the proxies of sovereign bond yields for the “risk-free” rate of return is becoming an increasingly imperfect substitute with potentially dangerous consequences” “The demise of the ‘risk-free’ rate in markets”, June 14.

Marcussen refers to “a new debate on how to treat sovereign debt on bank balance sheets. At present, sovereign debt enjoys favourable treatment not just in the euro area but across the globe. Basel III allows (but does not mandate) a capital requirement of 0 per cent for sovereign bonds”

Not exactly, as I have often written to FT, the problem of a not valid proxy for the risk-free rate originated much earlier, soon 30 years ago.

The Basel Accord of 1988, Basel I, set the risk weights for sovereigns at zero percent and that of citizens at 100 percent. Since that signified a regulatory subsidy of sovereign debt, ever since we have not have had a reasonable proxy for a risk free rate.