Mark Carney. Risk-weighted bank capital requirements, is extremely improper regulatory behavior.

Sir, I refer to Martin Wolf’s “Carney’s risky bet on big finance” October 30.

According to Basel II, if a bank expected a risk adjusted margin of 1% on a loan to Greece, or on a AAA rated security then, since that was risk weighted 20%, it would be required to hold only 1.6% in capital, and so it would be able to earn an expected risk adjusted return of 62.5% on its equity.

But, also according to Basel II, if a bank expects a risk adjusted margin of 1% on a loan to medium and small unrated businesses then, since that is risk weighted 100%, it would be required to hold 8% in capital, and so it would be able to earn an expected risk adjusted return of only 12.5% on its equity.

Sir, what would you expect the banks to do in such circumstances? Is this the “organized properly, a vibrant financial sector bring substantial benefit” that Mark Carney was referring? If so, Carney has no idea of what “properly” means.

And the ex ante perceived risks-weighting of capital requirements remains the pillar of Basel III, even though, with its leverage ratio, a floor of 3% capital (equity), and a roof of 33.3 to 1 leverage, has been set as an AVERAGE for the banks.

Martin Wolf feels that “Far more equity is required”. I agree, though it has to be something achievable and not a pie in the sky request of 30%, but, before that, risk-weighting needs to disappear. With more basic capital required, unless of course it becomes close to 100%, the more distortions could the risk-weights produce.

Mark Carney states “our job is to ensure that [the financial sector] is safe” He is so completely wrong! His job is to help to ensure that the real economy is safe, and, for that, the health of the financial sector is only one part of the puzzle.

PS. Sir, just to let you know, I am not copying Martin Wolf with this, as he has asked me not to send him any more comments related to the capital requirements for banks, as he understands it all… at least so he thinks.