May 06, 2015

The Basel Committee causes an inefficient allocation of bank credit, something which guarantees lower productivity.

Sir, Sam Fleming writes: “the efficient use of capital and labour is key to improving living standards, at a time when advanced economies face lower potential growth because of ageing populations”, “US productivity slowdown adds to concerns among policy makers” May 7.

Indeed, but current credit risk weighted equity requirements for banks impede bank credits to clear efficiently, by means of their credit risk adjusted net margins. That is because regulators allow banks to leverage their equity (and the support they receive from society) many times more when those margins are paid by those perceived as safe, than when the margins paid by those perceived as risky.

And that means, of course, that “the safe” will get too much bank credit at too low rates, while “the risky” will get too little at too high relative interest rates.

That inefficient allocation of bank credit caused by bank regulators, guarantees productivity will be negatively affected.

That regulators, academicians, financial experts and most financial journalists, including those in FT, stubbornly ignore this is truly mind-blowing. 

On May 6, in Berlin the Financial Stability Board (FSB) held a meeting of their Regional Consultative Group for Europe. The press release states: “The meeting was preceded by an informal seminar that considered how the financial reforms have changed bank business models and more specifically, capital strategies and capital structures.”

Sir, as you well know, there are no “changed bank business models” that do not imply some changes in the allocation of bank credit. Are regulators beginning to understand the mess they created? Lets hope so. It is more than a decade late.

PS. When the FSB or the Basel Committee refers to “capital” they basically signify “bank equity”.