November 07, 2017

The 0% risk weighting of sovereigns is a very subtle version of brutal top-down Stalinism. It will not work either

Sir, Sergei Guriev, the chief economist of European Bank for Reconstruction and Development concludes in that “The Great Soviet Experiment demonstrated the deficiencies and unsustainability of the non-market model” “The Russian Revolution offers economic lessons

But there, right in front of his eyes, he has bank regulations that with Basel I of 1988 decided, with respect to the risk weighted capital requirements for banks, that the risk weight of a sovereign is 0% and that of the citizens is 100%.

As a consequence banks can leverage their equity more, and therefore obtain much higher expected risk adjusted returns on equity when lending to the sovereign than when lending to the citizen. And therefore banks will lend much more to the sovereign than they would otherwise have done.

Sir, is that just not a much more subtle version of the brutal top-down Stalinism that Guriev writes about? Of course it is! And because it is de facto premised on that government bureaucrats will be able to use bank credit for which they are not personally responsible for better than the citizens, it will not work either.

Unfortunately, it would seem like that the Financial Times wants that statism to remain invisibly subtle.