May 11, 2009

The bottle that now matters is the one containing bank equity.

Sir Tony Jackson in “Is the liquidity bottle half-full or half empty” May 11 writes “If the banks can only hold Treasuries rather than private securities... The less the scope, too, for securitisation- the vital form of lending that has yet to recover”.

In other circumstances looking at the Treasury versus private securities from a liquidity angle might be correct but, at this particular injunction, the bottleneck for the banks is equity and not liquidity.

In this respect let me remind you that the minimum capital requirements concocted by the Basel Committee holds that in contrast to claims on private assets that do require holding some equity, although in some cases ridiculously small, claims on sovereigns rated AAA to AA- do not, as they are given a 0% risk weight.

As food for thought just think about what are fore-bankers would have thought of making a zero-reserve when lending to a Crown. But of course, a zero equity requirement is what the Basel Committee had to stipulate in order for the finance ministers in their AAA or AA- countries to cheer them on. Now if a sovereign were to be down-rated to A+ to A- then the risk weight goes up to 20% and if that would happen they would either have to change the minimum capital requirement or face the mother of all demand for bank equity.