September 30, 2016

More than tighter or looser, what EU needs are capital requirements that distort less the allocation of bank credit

Sir, I refer to Jim Brunsden’s “EU set to resist tighter capital requirements” September 30.

EU (and all other) needs to decide what’s more important for it, the short term stability of its banking sector, or the future perspectives of its real economy. If it is the first then increasing the capital requirements must be a priority.

But, if the real economy is more important, then instead of being more accommodating with the capital requirements, as is now being discussed, it needs much more to rid itself of those risk weighted requirements that so distort the allocation of bank credit.

That would not not necessarily entail having to increase too much bank capital. Some increases for holding what’s “safe” could be compensated by some decrease of capital required for holding what’s “risky”, like loans to unrated SMEs. The latter would not affect the stability of the banks since there is never excessive dangerous bank exposures built up with what is ex ante perceived as risky.

How to proceed? I do not have data to recommend something exact but, one way of doing it, could be that of assigning a risk-weight of 60% for all assets… and then increase it by 5% in order to reach 100% for all assets in eight years.

Another, much more cumbersome of course is to define individual capital requirements for each bank, starting with were each one of these currently find themselves.

And of course a Chilean type recapitalization plan that entails central banks taking much of the not performing loans off bank’s balance sheets, subject to conditions such a not paying dividends, and at one time having to repurchase those loans, would give a big needed boost to the whole credit market.

@PerKurowski ©