December 15, 2015

Regulators make banks earn higher risk adjusted ROE’s lending out the umbrella to those in the sun than to those in the rain

Sir, in 2003 as an Executive Director of the World Bank, in a formal statement I wrote: “The financial sector’s role, the reason why it is granted a license to operate, is to assist society in promoting economic growth by stimulating savings, efficiently allocating financial resources satisfying credit needs and creating opportunities for wealth distribution. Similarly, the role of the assessor –in this case, the Bank– is to fight poverty, and development is a task where risks need to be taken.

From this perspective the Financial Assessment Program Report might revolve too much around issues such as risk avoidance, vulnerabilities, stress tests and compliance with international regulations, without referring sufficiently to how the sector is performing its social commitments.

We all know that risk aversion comes at a cost - a cost that might be acceptable for developed and industrialized countries but that might be too high for poor and developing ones. In this respect the Bank has the responsibility of helping developing countries to strike the right balance between risks and growth possibilities.

In this respect let us not forget that the other side of the Basel [Committee’s regulatory] coin might be many, many developing opportunities in credit foregone.”

And I had started this fight against senseless credit-risk aversion already in 1997 with the first Op-Ed I had ever published “Puritanism in banking” 

And in 2009, in Martin Wolf’s Economist Forum, I prayed “Free us from imprudent risk aversion

So you can imagine how much I agree with Nobuchika Mori when he, as Japan’s regulator of financial markets and institutions now writes: “too much emphasis on stability can be harmful, especially in the long run. It may prolong and even perpetuate stagnation. Based on this experience, a shift to supporting finance for growth is needed now”, “Too much 'medicine' could make the system sicker” December 15.

Think of it. Mark Twain is quoted with saying “Bankers want to lend you the umbrella when the sun is out and take it back when it rains”. With credit risk weighted capital requirements, the regulators now also give our banks higher risk adjusted returns on equity when lending out the umbrella to those in the sun than when lending it to those in the rain.

@PerKurowski ©