March 23, 2014

The risk based capital requirements for banks represent a tragic crossroad of history

Sir, I refer to Simon Kuper’s great description of the assassination in Sarajevo which initiated World War I, “The crossroads of history”, March22. He writes that “you want to shout at Franz Ferdinand across history ‘Get out of town!’“ That was the kind o warning that some of us were shouting out when we saw what was coming at us in Basel II.

Really that day when someone came up with the suggestion that banks would be safer by means of capital requirements based on risks, more risk more capital, less risk less capital, and no one in the inner circle that mattered objected strongly enough … that day the world, especially the Western World, took the wrong path at the crossroads of history.

Not only would this regulation severely distort the allocation of credit to the real economy, but it would also make the bank system much riskier, since we know that all major crises have always resulted from, excessive exposures to what was ex ante considered as “absolutely safe”.

It was bad enough having already allowed banks to hold less capital when lending to the housing sector, since this ignored the fact that a house that comes without a job is really sort of a second class house… but then, allowing banks to earn higher risk adjusted returns on equity on what is perceived as “safe” than on what is perceived as “risky”, that really turned it into an outright criminal history changing event.

Kuper with respect to the Bosniche Post’s late edition “You sense a small local paper struggling to cope with the news story of the century”… and I sense the struggle of the Financial Times to ignore the financial story of the millennium!

Kuper also mentions that one of the two assassins who survived jail, Vaso Cubrilovic, has stated “It wasn’t our intentions to cause a world war”. But, Sir, the amazing fact is that those who were responsible for the Basel II AAA-bomb, those who of course had no intentions of causing us a bank crisis in the world, are still allowed to freely shoot down the prospects of jobs for our youth with their “improved” Basel III.