What Europe and America need is to return to straightforward conventional bank regulations

Sir, I refer to Wolfgang Münchau’s “Why Europe needs to try unconventional policy” November 18.

In it Münchau writes, with respect to a further cut by ECB of the interest rate that “We are in a situation of diminishing marginal returns”. And later he observes that “Since small and medium-sized companies in the eurozone are heavily reliant on bank finance, they are beyond the direct reach of a [QE]”.

Why is it so hard for some to connect the dots? Are they afraid of the picture they might find?

Those who can provide the highest marginal returns are the small and medium-sized companies, entrepreneurs and start ups, and who are in fact heavily reliant on bank finance, more so in Europe than in USA. And so the reason the returns are dropping, in Europe and in USA, is that those previously mentioned and who are in fact heavily reliant on bank finance, more so in Europe than in USA, have seen their access to bank credit seriously cut off by the risk-weighted capital requirements for banks.

Risk weighing capital requirements, which translates into banks being able to earn much much higher risk adjusted returns on their equity when lending to what is perceived as “absolutely safe” than when lending to what is perceived as risky is a loony unconventional concept that has only been around for about three decades but that really went crazy with the approval in 2004 of Basel II.

What Europe and America most need is instead return to what is really conventional, namely allowing the banks to discriminate on their own based on perceived risks, without the regulator reusing the same perceived risks for the purpose of determining the capital requirements.