March 18, 2011

FT is unbelievably inconsistent!

Sir suppose that the market, which includes banks, looks at the credit information, which includes credit ratings, and decides that the risk premium of a triple-A rated company should be 1 percent; and then it similarly looks at a company rated BBB and decides that the risk premium there should be 4 percent.

Now if a bank would have to hold 8 percent in capital for all its assets and therefore be able to leverage its capital 12.5 to 1 it would receive 12.5 percent of risk premiums on its capital when lending to a triple-A rated company and 50 percent of risk premium on its capital when lending to a BBB rated company, and it has deemed these risk returns to be equivalent.

But then comes the Basel Committee and in Basel II tells the bank that in the case of triple-A rated companies it can leverage 62.5 to 1 which means that now suddenly the banks receives 62.5 percent of risk premiums on its capital when lending to triple-A rated companies which in this case is, even on a gross basis, more risk premiums than what is obtained when lending to BBB rated companies.

How can you then reward Boldness in Business March 17, and yet not say a word about the distortive risk aversion of current bank regulations? You are being unbelievably inconsistent.

Did the financial crisis originate from anything officially or unofficially perceived as risky? Of course not! They never do.