June 24, 2015

Capital requirements for banks weighted for environmental and job creation concerns, would at least serve a purpose.

Sir, Martin Wolf writes: “The best way of responding to the challenge of climate change is through changed incentives and accelerated innovation aimed at making carbon-free technologies competitive with fossil fuels. Both demand more active public policies.”, “A moonshot to save a warming planet”, June 24. He is correct but one of the active public policies that need to be reviewed is that of bank regulations.

Currently the Basel Committee’s risk weighted capital requirements for banks clears for the only risk that has been previously cleared for by banks, namely credit risk. That is as loony as can be, since it distorts the allocation of bank credit for absolutely no purpose at all. These should be based on the risk that bankers are not capable to manage perceived credit risks… which c'est pas la même chose. In fact it can be shown that it is when the perceived risks are really low, that bankers have encountered the biggest problems.

If bureaucrats absolutely must distort, because that is their modus vivendi, if their capital requirements were based on environmental and job creation concerns, then these would at least align much better with an identifiable worthy social purpose... think of earth sustainability and job creation ratings!

Of course more publicly funded research and development on renewable could help… but let us not ignore the importance of allowing banks to take more risk; to leverage their equity and the support we lend them as taxpayers more; and therefore to earn higher expected risk adjusted returns on equity, when their risk-taking makes much more sense to us.