April 30, 2014

Regulation which favors access to bank credits of the “safe” over the “risky” dooms the economy to stagnate

Sir, Martin Wolf in support for his usual begging for fiscal deficits to be invested in infrastructure, refers to Lawrence Summers in that “the high-income economies seem to be worryingly unable to generate good growth in demand without extreme credit instability”, “How to stir life into a stagnant world”, April 30. And I wonder what they consider “extreme credit instability”? Is it, as I presume they mean having banks lend to the “risky”? If so, that is totally wrong!

As I see it, the real poison that has infected our economies, are the capital requirements for banks based on ex ante perceived risks that were introduced with Basel II, in June 2002. These regulations allow banks to earn much higher risk-adjusted returns on equity when lending to the “safe” than when lending to the “risky”; which obviously results in the banking system lending much too little to the risky, like medium and small businesses, entrepreneurs and start-ups, and much too much to the “infallible”.

And that Wolf is able, in April 2014, to write about “changes in portfolio preferences towards safe assets” without mentioning these pathological risk adverse regulations hard to understand, that is unless he has a personal reason for hiding it.

At all times we hear about the importance of risk taking… only last night in America, in “The Voice”, one of the judges, Blake Sheldon, reminded the performers that “the worst thing you can do is to play it safe”.

Our bank regulators have got it so unbelievably wrong. Any real risk management session, in order to keep the right perspective, should start with the question of: What is the risk we cannot afford not to take? And in banking the answer would be: We cannot afford to stop our banks from opening the “risky” doors behind which we might those lucky nuggets that will keep our real economy moving forward, so that it does not stall, so that it does not fall.

Sir, of course we have a stagnant world! How could it be otherwise with these bank regulations?

And if to top that up you take into account that all bank crisis always result from too much exposures to something erroneously considered safe, and none because of excessive exposures to what is considered risky, then you really begin to understand how absolutely insane these bank regulations are. 

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.