October 21, 2016
Sir, I refer to Claire Jones reporting on Mario Draghi’s difficulties on deciding what to do “to come up with a stimulus package that convinces markets the ECB is doing enough both to keep the fragile recovery on track and to keep hawks on his governing council onside”, “ECB has six weeks to update QE, says Draghi” October 21.
Mario Draghi was the former chair of the Financial Stability Board, and is the currently the President of the European Central Bank and chair of the Group of Governors and Heads of Supervision of the Basel Committee for Banking Supervision. No doubt that in the area of high-finance, Draghi is about as important as one can be… perhaps more important than one should be allowed to be.
Because Mario Draghi, though he might be a very knowledgeable technocrat, in the sense that he knows for instance that it can be quite risky for a bank to lend to an unrated SME, something with which all bankers would agree, is unfortunately not sufficiently wise to understand that what is for instance rated as super-duper safe AAA, is what can be truly dangerous for banks, precisely because bankers do also not think that to be dangerous.
And unfortunately Mario Draghi, like his regulatory technocrat buddies, seems also to have missed out on a Finance 101 course. That because seemingly he does not understand that when you allow banks to leverage more their equity, and the support these receive from society, with assets that are perceived safe than with assets perceived risky, banks will invest more than usual in what’s safe, because there is where it will obtain higher expected risk adjusted returns on equity. And the consequences of that are twofold, and both negative. First it leads to dangerously overpopulating the safe havens, and second, equally dangerous, especially for the real economy, to underexploring those risky bays where SMEs and entrepreneurs reside.
As an example, the risk weight the Basel Committee has assigned to the financing of residential housing is 35%, while that for unrated SMEs is 100%. This causes banks to finance the basements where the kids can live with their parents, but not the necessary job creation required for the kids to be able to become themselves parents in the future.
It is truly shameful! Europe (and world) wake up!