July 23, 2015

There’s a curious silence about the odious distortion the Basel Committees' credit-risk-weighted capital requirements produces

Sir, suppose Martin Wolf owned an unrated SME, and Per Kurowski was the CFO of an AAA rated corporation, and both wanted to obtain bank credit for their company. 

Traditionally, naturally, before the Basel Committee’s risk-weighted capital requirements existed, because of clear differences in the perceived credit risk, Per Kurowski would be able to negotiate much more credit, and at much lower interest rates for his AAA rated corporation, when compared to what Martin Wolf could do for his unrated SME.

But now, because regulators decided banks also need to hold more capital when lending to Wolf’s SME than when lending to Kurowski’s AAA corporation, the differences in the amounts of credit obtained and the interest rates charged would be even larger. In other words Wolf’s SME, relative to Kurowski’s AAA, would obtain even less credit, and would need to pay even higher interest rates, than in the absence of these credit risk-weighted capital requirements.

Of course Kurowski does not complain that his AAA rated corporation has access to even more credit at even cheaper rates, and consequentially he himself to larger bonuses.

And of course banks, as a consequence of having to hold little capital and therefore be able to leverage hugely when lending to Kurowski’s AAA rated corporation, do not complain about being able to earn higher risk-adjusted returns on equity when lending to Kurowski’s AAA rated corporation. In fact obtaining the highest risk adjusted returns on equity for what is perceived as safe, sounds like a banker’s dream come true.

But Martin Wolf should of course be furious that bank regulators deny his SME fair access to bank credit.

And of course anyone who calls himself a progressive should be furious against this odious regulatory discrimination that denies fair access to the opportunity of bank credit to those who already find it hard enough to obtain bank credit. That clearly promotes inequality.

And of course anyone who calls himself a free markets defender should be furious about this odious regulatory distortion of the allocation of bank credit to the real economy.

But curiously, Martin Wolf as a journalist, FT, progressives and free market defendants, they all keep mum about it. Is it not a strange world?