June 24, 2009

Don’t just pick on the fallen bankers.

Sir it is clear as Martin Wolf writes “Reform of regulation has to start by altering incentives” June 24. That said it is hard to understand exactly what incentives Wolf is referring to since most of the problem he describes are an intrinsic part of the realities of banking and therefore, if he just wishes to eliminate banks and go for safe mattresses instead, then he should perhaps say so.

The incentives I most worry about are those arbitrary incentives created by the regulators in Basel and that state among others that if a bank lends to a corporation without a credit rating it can leverage its capital 12 to 1 but if lending to a corporation that has managed to obtain a credit rating of AAA to AA- then it is allowed to go for an incredible leverage of 62.5 to 1… and as if the good risks needed additional subsidies.

Talk about incentives to pursue the AAAs! With incentives like these no wonder many of the AAAs weren’t for real. Like many, Wolf also expresses concern about the “too big to fail banks”. Had he participated in the few debates prior to the approval of Basel II in June 2004, he would have known that this was exactly one of the major concerns and that unfortunately was finally brushed aside.

We know that the bankers are down for counting so it is understandably tempting to pick on them but please let us first and foremost go after on the truly horrendous regulatory incentives which perhaps are also easier to correct.