August 21, 2014

Mario Draghi’s “Whatever it takes” should include Draghi going into early retirement.

The pillar of current bank regulations, those concocted in Basel II and surviving in Basel III, the risk-weighted capital requirements for banks, determine: less-risk-less-capital, more-risk-more-capital.

But what is perceived as “risky” is only risky, if it is more risky than what it is perceived to be. And what is perceived as “safe” is not safe, if it is less safe than what it is perceived to be.

And therefore the current capital requirements for banks based on perceived risk is utter nonsense since, if something like that could help our banks to be safer, it should at least be based not on the perceived credit risks, but on the risks of the perceived risks not being correctly perceived.

And, in such case, can someone really determine what is more risky than what it is perceived to be is, or what is less safe than what it is perceived to be is? I guess not.

But no! The Basel Committee regulators felt they had full authority to know best, and here we now have our banks being allowed to hold little capital against monstrously large exposures if these are only perceived as safe, like AAA rated securities, loans to infallible sovereigns like Greece, or real estate financing in Spain; while being required to hold much more capital against an immense number of small loans to SMEs, or entrepreneurs, only because these creditors, individually, are perceived as risky.

And that means that banks can leverage more their equity with “absolutely safe” assets than with “risky” assets; which results in banks being able to earn higher expected risk-adjusted returns on equity when lending to what is perceived as “absolutely safe”, than when lending to what is perceived as risky.

And that has of course completely distorted the allocation of bank credit to the economy… and therefore utterly diluting the significance for the economy of QEs, fiscal deficits, low interests, or any other similar stimulus.

And one of those most responsible for causing these distortions which are murdering any hopes of a sturdy economic growth in Europe, and the creation of jobs for our young, is of course the former chairman of the Financial Stability Board, Mr. Mario Draghi.

And therefore Sir, when Richard Portes now suggests that “Draghi has to do, as well as say, whatever it takes” August 21, I feel that “whatever it takes” should include Mario Draghi going into early retirement… and of course taking some other of his failed bank regulating colleagues with him.

And, if you consider that to be inappropriately harsh, then would you at least require him to publicly confront and answer this criticism of the risk-weighted capital requirements.

PS. It is a real tragedy hearing so many opining on current bank regulations, and being convinced we are now much better off with Basel III, without them having read, much less understood, what is said in that monument to mumbo jumbo document that is “The Basel Committee on Banking Supervision´s Explanatory Note on the Basel II IRB Risk Weight Functions of July 2005”. I am sure Draghi did not understand it… or at least I hope he did not… as otherwise that would be so much worse.

PS. If we do not at least learn to hold especially accountable those whose regulations have a global reach, then we are really setting us up for total disaster.