July 28, 2016

Basel risk-weights: Sovereign 0% - We The People 100%. How on earth did we fall into that idiotic statist trap?

Sir, David Stubbs discusses accurately many risks with sovereign debt, risks that are not new, have never been, but that are appearing more clearly now. “Sovereign bonds can steady a ship but their anchor days are over” July 28.

But what Stubbs leaves out is the amazing fact that, for the purpose of risk-weighing the capital requirements for banks, the Basel Accord, Basel I, in 1988, set the risk-weight for the sovereign at 0% and that of “We The People” at 100%... and no one said a damn word about it. The only discussions thereafter were promoted by some shadier sovereigns that also wanted to be risk-weighted at 0%.

Sir, you can be sure of one thing, Greece, independently of how much it hid information, would never have been able to get so much credit, had there not been for the minimalistic bank capital requirements against its loans.

Runaway statism is what was, and is, behind it all. By allowing banks to leverage their equity so much more with sovereigns’ debts than with citizens’ debts, they allow banks to earn much higher “expected” risk-adjusted returns on equity when lending to sovereigns than when lending to citizens, so banks will favor lending to sovereigns over lending to citizens.

And that means de facto that bank regulators are acting as believing government bureaucrats know better what to do with bank credit than citizens. How on earth did we fall into that trap?

Would the actual level of sovereign debts around the world be sustainable without the regulatory subsidies? That is indeed a nasty question.

PS. A letter in FT November 2004 “How many propositions will it take before the Basel Committee, the bank regulators, start realizing the damage they are doing by favoring so much bank lending to the public sector.”

@PerKurowski ©