June 01, 2016

Regulators, your risk management, need to start by asking: What risks can we not afford the banks not to take?

Sir, I refer to Martin Wolf’s “Central banks as pawnbrokers of last resort”, in which he discusses Mervyn King’s suggestions as expressed in the book “The End of Alchemy”.

Again, falling sparrow included, Wolf’s and King’s primary, almost only objective, is to make banks safe, referring to the back room what many of us would consider a banks primary social purpose, that of allocating credit efficiently to the real economy.

They might defend a “leverage ratio”, but that is solely out of bank safety concerns, and not out of any sort of concerns that the current risk weighted capital requirements for banks hugely distorts the allocation of credit.

Wolf writes: The new improved safer banks would hold “Reserves at the central bank plus the agreed collateral value of any other assets [that] should match institution’s liquid liabilities, defined as loans of a year’s maturity or less”.

Where would the Western world be if its banks had always been required to hold after haircut collateral against all its liquid liabilities?

Also since regulators would certainly assign to the governments the lowest haircuts, they would not dare doing elsewise, it would mean that all “liquid liabilities” will basically fund the government.

Don’t we already have had enough of that statism that is reflected in the risk weight for sovereigns being zero percent, while the risk weight of the citizens that give the sovereigns it strength is 100 percent?

And speaking about the haircutters, don’t we have had enough with regulators who assign to those prime rated AAA to AA a 20% risk weight, while those who are rated speculative and worse below BB-, and are therefore totally innocuous, are given a risk weight of 150%?

Sir, I don't think central bankers could survive as pawnbrokers. Its a too competitive business… I can see them being gamed and getting stuck with a lot of “valuable” possessions worth nothing.

Martin Wolf writes that King’s “ideas deserve open-minded consideration”. Of course they do! But can we please, for once, begin by discussing the need for all borrowers to have equal fair access to bank credit? That which has nothing to do with the riskier being charged higher interests and getting smaller loans, but with the loans to the “riskier” generating higher capital requirements for the banks or, in this case, receiving higher haircuts as collaterals.

The risk we can least afford our banks to take, is that of these not financing the riskier future but only refinancing the safer past; is that of only supplying carb credits to the real economy and not the protein rich loans to SMEs and entrepreneurs.

A ship in harbor is safe, but that is not what ships are for.” John A Shedd, 1850-1926

@PerKurowski ©