Banks with better capital will not stifle investment and growth. Bank capital requirements that are not neutral to perceived-risks will

Sir, I refer to David Miles, Professor of Financial Economics, Imperial College letter in which he argues that “Better capitalized banks will not stifle investment and growth” November 30.

He is of course right, but with some caveats.

First, it has to be reasonably well capitalized banks since, going overboard on capital requirements, might reduce the margins arising from leveraging and make getting that additional capital (equity) needed quite difficult.

Second, it is a delicate matter of how going from here to there. If you impose some drastic immediate adjustments then you must be prepared to go for instance the Chilean way, where its central bank made some important capital contributions but allowed former shareholders to repay them and buy them out when they could.

But, but, but! If you insist in that capital being risk weighted, it will just not work.

Suppose you want a 100% capitalized bank, but when calculating that 100% you keep on risk weighting the sovereign with 0%. That would mean that a bank would come up with 100% of equity if lending to a 100% risk weighted entrepreneur, but would be allowed to hold zero capital (equity) when lending to the sovereign. Would that just not be 100% top down Stalinism? How much non-governmental jobs could be created that way?

So, if we are to have economic growth, and banking sector stability, much more important than how well capitalized is that they are perceived-risk neutral capitalized. 

Sir, you know how much I have been criticizing current bank regulations, but my first Op-Ed ever, in 1997, was titled “Puritanism in Banking”, and I still think that what we least need is too much of that. God make us daring!

And, since I will try to copy this letter to Professor Miles, I will hereby take this opportunity to ask him whether he has any idea of why regulators want banks to hold the most capital for when something perceived risky turns out risky? Is it not when something perceived ex ante as very safe turns ex post out to be very risky, that one would like banks to have the most of it?

http://perkurowski.blogspot.com/2016/04/here-are-17-reasons-for-why-i-believe.html 

@PerKurowski

If bank credit was allowed to flow freely, central bankers´ quantitative easing would help so much more

Sir, David Miles with respect to quantitative easing tells us to “Ignore the pessimists – central banks are helping” June 28. Even if we accept that, the fact remains that they could be helping so much more, if they allowed the financial resources represented by bank credit to flow freely to where in the real economy these could be put to best use, and not just where they are perceived to be safer.

And this is so because when you allow a bank much less equity for what is perceived as “absolutely safe” than what is perceived as “risky” you are effectively allowing a bank to earn much higher risk-adjusted returns on their equity when lending to “The Infallible” than when lending to “The Risky”, like unrated small and medium businesses and entrepreneurs, and that only distorts.

Blefuscu’s and Lilliput’s bank regulators at war

Sir, John Plender’s “UK’s banking climate is making the US look attractive”, April 6, refers to the debate about the basic capital requirements for banks, whether the 7 percent proposed in Basel III or the 16-20 percent championed in this case by David Miles of the Bank of England.

Pure Blefuscu and Lilliput war material. The current crisis had nothing to do with the basic capital requirements and all to do with that these where applied in such a way that discriminated incredibly much in favor of what officially was perceived as having a low risk of default, the triple-As, even though the market already discriminated in its favor.

Three years into the crisis and regulators do no still know what hit them? How on earth can we allow the regulators to produce a Basel III after that incredible box-office flop of Basel II?