Higher bank capital ratios without eliminating distortions based on perceived risks, would make banks riskier

Sir, John Plender refers both to the draft legislation advanced by US senators David Vitter and Sherrod Brown, and to Anad Admati’s and Martin Hellwig’s “The bankers’ New Clothes”, in order to point out that “Support is growing for higher bank capital ratios”, May 8.

Plender unfortunately entirely misses what is most important. Many have asked for higher capital requirements but, what sets those he references apart from many others is that they also want to do away with the pillar, and the pride and joy of Basel regulations, namely that the capital requirements are to be based on perceived risk.

Let me ask Plender. Today, according to Basel II, a bank can hold some zero risk weighted sovereign assets against zero capital, while giving a loan to a business requires it to hold 8 percent of it in capital. If tomorrow the risk-weights for some sovereign would remain zero, but banks were instead required to hold 30 percent against a loan to a business, would the distortions be smaller or larger?

Risk-weighting for risks already weighted for, well that is regulatory zealotry you can write home about

Sir, you write that “the Fed’s monetary policy [is] much more efficient than in those economies where the transmission of central bank money-printing to real economy remains broken” “If the Fed ain’t broke, don’t fix it” May 1.

Indeed but the reason of that is that the US never adopted as fully as Europe did those Basel dictated capital requirements based on perceived risk, that so completely have clogged up the channels whereby bank lending can flow to the real economy.

And when you refer to that US Senators Sherrod Brown and David Vitter want banks to hold more capital you are ignoring that their bill contains the much more important provision of limiting [and hopefully making away altogether] with the obnoxiously dumb risk-weighting, something that is not explicitly mentioned in the Dodd-Frank law.

Sir, you mention the dangers of “zealotry”. Let me inform you that the worst example of regulatory zealotry is precisely the setting of capital requirements based on perceived risks that have already been cleared for.

Sir, as I wrote in a letter published today by the Washington Post, “Europe would also do better with a Brown-Vitter proposal”