November 13, 2015

No President Obama. No country with bank regulations based on credit risk aversion can speak of having a bold voice

Sir, Barack Obama writes “the US is ready to lead a global effort on behalf of new jobs, stronger growth, and lasting prosperity for all our people well into the 21st century. “America’s bold voice cannot be the only one” November 13.

He mentions: 1. “fiscal policy that supports short-term demand and invests in our future”; 2. “boost demand by putting more money into the pockets of middle-class consumers who drive growth”; 3. “more inclusive growth by lowering barriers to entering the labour force.” 4. “high-standard trade agreements that actually benefit the middle class” 5. “greater public investment… through new private investment in clean energy.”

Nowhere does he make a reference to the need of getting rid of bank regulations that are blocking the risk-taking needed to achieve sustainable economic growth.

The pillar of current bank regulations is the credit-risk weighted capital requirements for banks; more risk, more capital -less risk, less capital. Since banks, when deciding on risk premiums and amounts of exposure, already clears for credit risk, this results in an excessive consideration of credit risk. Any risk, even though perfectly perceived leads to the wrong results if excessively considered.

And therefore, in words attributed to Mark Twain, we now have banks that lend you the umbrella, much faster than usual if the sun is out, and take it away, much faster than usual if it seems like it could rain. In other words our bank’s, by having been given permissions to leverage much more with what is perceived as safe, earn much higher risk-adjusted returns on equity when lending to the safe are, consequentially, behaving more risk-averse than ever.

If one wants banks to be constructively bold, then one should set the capital requirements based, not on pitiful credit risk weights, but on daring purpose weights, like for instance based on “clean energy” and job-creation ratings, and SDGs in general.

And this will not cause the banking sector to become unstable, just the opposite. Never ever are major bank crisis the result of excessive exposures to something perceived as risky when placed on the balance sheets of banks… only of something ex ante perceived as safe that ex post turns out risky.

PS. This is also a civil rights issue. These regulations that double down on credit risk, discriminate against the rights of the risky, like SMEs and entrepreneurs, to have fair access to bank credit.

@PerKurowski ©