August 03, 2016

Loony technocrats told countries: “In order for you to develop and grow, your banks must avoid taking risks”

Sir, Professor Angus Deaton writes: “The ‘what works’ agenda also runs of the risk of replacing what (local) people want by what (often foreign) technocrats think they ought to have. It is these unintended consequences that explain why many projects succeed while the country fails.” “There is a solution to the aid dilemma” August 3.

What if one of these foreign technocrats would tell a developing country the following:

"You should require your banks to hold more capital against what is perceived as risky so that it earns higher risk-adjusted returns on its equity on what is perceived as safe, like the government and the financing of houses; and so that they stay away from lending to the risky, like SMEs and entrepreneurs."

With that these foreign bank regulation technocrats would de facto have told a developing country that it must foster risk aversion among its banks. Absolutely crazy! To give a developing country such recommendations is criminally dumb, but that is precisely what the Basel Committee has and is instructing.

Of course these regulations affects developed countries too, as it hinders them from further climbing up the ladder of development, but, in their case, they have at least reached an fairly reasonable height… although that also means the fall could be bigger.

PS. Let me quote the following from John Kenneth Galbraith’s “Money: “whence it came, where it went” (1975):

For the new parts of the country [USA’s West]… there was the right to create banks at will and therewith the notes and deposits that resulted from their loans…[if] the bank failed…someone was left holding the worthless notes… but some borrowers from this bank were now in business...[jobs created] 

It was an arrangement which reputable bankers and merchants in the East viewed with extreme distaste… Men of economic wisdom, then as later expressing the views of the reputable business community, spoke of the anarchy of unstable banking… The men of wisdom missed the point. The anarchy served the frontier far better than a more orderly system that kept a tight hand on credit would have done…. what is called sound economics is very often what mirrors the needs of the respectfully affluent.

The function of credit in a simple society is, in fact, remarkably egalitarian. It allows the man with energy and no money to participate in the economy more or less on a par with the man who has capital of his own. And the more casual the conditions under which credit is granted and hence the more impecunious those accommodated, the more egalitarian credit is… Bad banks, unlike good, loaned to the poor risk, which is another name for the poor man.

Per Kurowski