September 13, 2018

Banks, except for limited liquidity purposes, should not be dabbling in sovereign bonds

Sir, Reza Moghadam vice-chairman for sovereigns and official institutions at Morgan Stanley, in order to “provide more stimulus to slower-growing economies” proposes that “ECB should lengthen the maturity profile of the bonds it holds of slower-growing economies [as] Other things being equal, a flatter yield curve is more stimulative, as it encourages investment, and, by raising the price of long-dated bonds, strengthens the capital position of banks that hold them.” “A new twist in the ECB’s reinvestment policy”, September 13.

That reads as Moghadam hopes that ECB, indirectly, in a veiled way, helps to capitalize banks (and his department shine). It should not do so.

In my mind, if we want the real economy to stand a chance of sturdy and sustainable growth, banks should instead, little by little, be made to reduce the financing of public debt, most specially of its own sovereign, that to which they have been guided by very statist very low capital requirements. 

As fast as possible, banks should be allowed to hold the same capital when lending to entrepreneurs and small and medium businesses, as they are required to hold against sovereigns, residential mortgages and AAA rated securities. Only that way do the banks stand a chance to allocate credit efficiently to the real economy. 

In 2004, coming from a developing country, in a letter published by FT I asked: “How many Basel propositions will take before regulators start realizing the damage they are doing by favoring so much bank lending to the public sector. In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits.” That clearly applies now also to developed nations.

PS. Sovereign bonds, if so safe, at interest rates not subsidized by regulations, should primarily be available for pension funds and insurance companies.

@PerKurowski