More than the destination it is the road travelled that counts

Sir, Prof Eric De Keuleneer suggests that “Bank just might have too much equity” December 13. That is oversimplifying it. Banks are required absolutely too little capital, zero to 1.6 percent, when lending to what is perceived as having a low risk of default, and therefore, strictly in relative terms, much too much capital, 8 percent, when lending to what being perceived as riskier, like the small businesses or entrepreneurs who are indispensable to the economy as a whole.

In that respect what should be done is to temporarily reduce the capital requirements for what is perceived as risky, to whom bankers will presumably still not lend excessively to, much less without more careful studies, so as to make the journey to “sufficient bank capital” a less discriminatory venture.

I support of course to De Keuleneer´s recommendation that “the credit rating agencies should be used less and with less authority”; that is an absolute must if we want to return our bankers from that world where they do not need to have an opinion of their own but are satisfied with monitoring the opinions of others.

CDS on US public debt is more of a toy gun.

Sir Eric De Keuleneer worries that a Dr. Strangelove could set out to destroy our world with credit default swaps (CDS) on US debt “Tomorrow could bring a new threat” December 12. This is not so these CDS are just toy guns.

Any problem with the US debt will show up as inflationary expectations in the required interest rates since all it currently takes to defuse a CDS on US debt is some paper and ink, printing dollars. As I have written to you earlier, November 21, Dr. Strangelove possesses much real mass destructive power when he rides on the credit ratings, and which is why perhaps a more cautious regulator would request a security clearance for all the individual credit risk raters.

Having said that, in today’s nervous financial climate, even a toy gun could produce panic.

And then on top of it all there is the regulatory tax on risk.

Sir I could not be in more agreement with what Eric De Keuleneer has to say in his letter “Step up competition for banks and rating agencies”, May 12 in relation to taking away the powers the credit rating agencies have been given to distort the markets, as you must know having received at least 100 of my letters on the subject over the last years. That said Mr. De Keuleener does not mention the current tax that the minimum capital requirements for banks impose on risk.

Under the current Basel I Standardized Approach, a low risk corporate loan (rated AAA to AA-) requires a bank to hold only 20% of the basic 8% capital requirement, meaning 1.6 in units of capital, while a much riskier loan (rated below BB-) requires it to hold 150% of the basic 8%, meaning 12 units of capital. If the current cost of capital for the bank is 15%, then the bank's carrying cost for the low risk credit is 0.24% (8%*20%*15%) while the bank's carrying cost for the high risk credit is 1.80% (8%.150%*15%), thereby producing an additional cost of 1.56% that must be added on to the normal spread that the market already requires from the higher risk credit when compared to the lower risk one.

This mind-boggling 1.56 basis points regulatory tax on riskier but frequently more needed credits when compared to low risk but often not so productive loans, dwarves any Tobin tax proposals both in terms of costs and distorting signals, but it is blithely ignored.

Don’t go overboard blaming the investment bankers

Sir, Prof Eric De Keuleneer sounds more than upset in his “Investment bankers have behaved like pyromaniac firemen” January 8. Of course many of them did wrong but, before he spits out more venom, and most especially before he suggests new and tighter regulations, he would do well to study how much the investment bankers have in fact only been responding to the current regulations. As I see it, in history of mankind, there have never been as stringent financial regulations as now, when everyone has basically been ordered by the regulator to follow the tune of the piper, the few credit rating agencies.