March 20, 2009

Do not tax Gekko-style risk-taking.

Sir Gillian Tett writes about “That secret desire for burst of Gekko-style risk-taking” March 20 and that must lie very close to the heart of anyone looking for a speedy recovery.

May I suggest she reads the following table derived from the Minimum Capital Requirements for the Banks issued by the Basel Committee under the Standardized Approach in order to cover for Credit Risk:

Rating of the ......Required Bank...... Allowed
Corporation ......Equity $100 Loan ...Leverage
AAA to AA- ..........$ 1.60 ....................62.5/1
A+ to A- ...............$ 4.00 ....................25.0/1
BBB+ BB- .............$ 8.00 ....................12.5/1
Below BB- ............$14.00 ...................8.33/1

From it she should be able to conclude that the regulators have imposed, on the core of our financial system, the commercial banks, a de-facto tax based on a loosely defined “default risk” and as measured by the credit rating agencies.

When as now bank equity is scarce and very expensive this de-facto tax on risk, which is charged on top of whatever the market commands for assuming higher risks, is extremely high. So, if you want Gekko-style risk taking? Start by not imposing special taxes on it.