We do not need banks avoiding risks we need banks taking the right risks.

Sir, Vikram Pandit in his comment on “Capitalism in crisis” January 11 rightly refers to the capital requirements for banks set by the regulators based on perceived risk of default as a (arrogant) presumption of “clairvoyance no regulator can posses”. I totally agree with that, but then he suggests bettering the system by having the banks comparing the risk profile of their assets with some “benchmark” portfolio created by the regulators. 

Ha! What would have happened in the building up of the current crisis? Those banks that had held the most of ex-ante triple-A rated securities and of infallible sovereigns would have certainly compared great against the benchmark, and be rewarded for that, but could then have been among those who turned into the worst nutcases when the ex-post realities set in. 

And, if the banks already now shy away way too much from taking on the real risky but rewarding prospects we need them to take, such as lending to the small businesses and entrepreneurs, they would do more so, if subject to a new sort of “neutral” measurement tool. 

Mr. Pandit and Mr. Regulator, we know you are looking to the safety of the banks, but, we other humans need to look at the safety of our economy and the prospects of creating jobs for our grandchildren, and neither capital requirements based on perceived risk nor a “benchmark” portfolio has anything to do with that… on the contrary these just make our prospects so much dimmer.

Vikram Pandit might need to go back to banking school

Sir in “We must rethink Basel, or growth will suffer” November 11, Vikram Pandit, the Citigroup chief executive, after making a lot of sensible comments about the difficulties of measuring risk, says: “No one disputes that riskier loans should be backed by higher level of capital”.

Surprising, is Pandit not aware that Citigroup, and all other bank for that matter, charge riskier clients higher interest rates and that does risk-premiums go straight into capital? Does he not know that the risk level of any operation is often not reflected in the amount of capital required but in the cost of capital raised?

Capital requirements based on ex-ante risk perceptions simply do not make sense… except if you are to charge all bank clients the respective weighted-capital cost, plus the same risk-premium. Is Citigroup willing to do that?

The development economists, they have now been shamed.

Now most development economists have been shamed by none other than Vikram Pandit, the chief executive of the Citigroup and who, in the Financial Times of October 26, is reported by Francesco Guerrera as saying “Under Basel, the ‘sweet spot’ business model for banks in the developed world will be to take retail deposits from mom and pop – small but stable customers – and lend only to big business and the wealthy. I do not believe this is the banking system we want”

Of course this is not the arbitrary regulatory discrimination we need, and I have been arguing against it since 1997 with for example a document I presented at the UN in October 2007 titled “Are the Basel bank regulations good for development?”. Unfortunately much of the development debate has been hijacked by baby-boomer development economists from developed countries and who cannot get it in their head that development requires a lot of risk-taking… and that therefore concentrating too much on avoiding bank failures will hinder the growth and the development of the economy.

As an example it suffices to read the Recommendations by the Commission of Experts of the President of the General Assembly on reforms of the international monetary and financial system chaired by Joseph Stiglitz. Nowhere in it do we find a word about the utterly misguided and odiously discriminatory capital requirements for banks imposed by the Basel Committee and which signify that a bank needs to have 5 TIMES more capital when lending to small businesses and entrepreneurs (100%-risk-weight) than when lending to triple-A rated borrowers (20%-risk-weight); and this even though the first are already paying much higher interest which goes to bank capital; and this even though no financial crisis has ever resulted from excessive lending to those perceived as “risky” as they have all resulted from excessive lending to those ex-ante perceived as not risky.

The Commission of Experts speak of increasing risk-premia but fail to notice that one of the reasons for that is the arbitrary regulatory risk-adverseness. It also speaks out against under-regulated and dysfunctional markets that fail to allocate capital to high productivity uses, without noticing that perhaps the major cause of markets being dysfunctional is often bad regulations, such as those issued by the Basel Committee.

Perhaps it is high-time economists from developing countries start to develop their own development paradigms; some of which might even help developed countries to keep from submerging.

And meanwhile, all you traditional development economists, put on your cones of shame.

A final question should Vikram Pandit now move to the World Bank?