February 02, 2016

Regulators impede many who represent the driving force of capitalism from competing for bank credit in fair terms

Sir I refer to John Thornhill’s interesting discussion of organizations’ internal obstacles to competition and innovation “The path to enlightenment and profit starts inside the office” February 2.

Thornhill states “As the driving force of capitalism, competition gives companies a purpose, a mission and a sense of direction” but unfortunately “The incentive structures of many companies are to minimise risk rather than maximise opportunity. “Innovation is often a young company’s game.”

But let me pick up on that to remind you, for the umpteenth time, of the nasty consequences of current credit-risk-weighted capital requirements for banks. These allow banks to leverage more with exposures to the safe than on exposures to the risky; and so banks are therefore able to earn higher expected risk adjusted returns on equity when lending to the safe than when lending to the risky. And so the current regulatory incentives given to banks are set in order to minimize their exposure to any “risky” assets, rather than to maximize the opportunities that could easier result were banks free to allocate their credit to the real economy without distortions.

Thornhill mentions: “Innovation is often a young company’s game.” Yes and it is precisely “young companies” that usually are perceived as “risky” and are therefore now blocked from competing for access to bank credit in fair terms.

PS. Thornhill also refers to Herman Hesse’s “Knowledge can be communicated. Wisdom cannot.” In 2003, as an Executive Director of the World Bank, and in relation to the financial sector I wrote the following in a formal statement delivered at the Board:

“As the financial sector grows ever more sophisticated, making it less and less transparent and more difficult to understand for ordinary human beings, like EDs, it is of extreme importance that the World Bank remains prudently skeptical and vigilant, and not be carried away by the glamour of sophistication. In this particular sense, we truly believe that the World Bank has a role to play that is much more important than providing knowledge per-se and that is the role of looking on how to supply the wisdom-of-last-resort.”

Unfortunately, even though the World Bank is the world’s premier development bank, it has not yet explained to the world that risk-taking is the oxygen of any development.

@PerKurowski ©