Bank credit should flow to where it most benefits the economy, but regulators only care about avoiding credit risks

Sir, Minouche Shafik, a deputy governor of the Bank of England writes: “We need to make sure the parts that are growing are safe and sustainable so that globalization evolves in ways that direct capital to where it has the most benefit for the world economy” “Globalization is changing, not going into reverse” April 15.

Of course she is right. The question though is why then do regulators insist with their risk weighted capital requirements for banks? These have absolutely nothing to do with directing credit to where it has the most benefit for the economies. These have only to do with having banks avoid lending to those ex ante perceived as risky. And of course that distortion of credit allocation does nothing to promote financial stability, as it only guarantees that those perceived, decreed or concocted as “safe” will get too much credit, while those perceived as risky, like SMEs and entrepreneurs, will get too little.

Worse yet, since major financial crisis never ever detonate because of excessive exposures to something perceived as risky, but always because of excessive exposures to something erroneously perceived as safe, that regulation just makes it all worse, since the banks, when suddenly caught with their pants down, will then have especially little capital to cover up with.

Bank regulations need a complete overhaul. And that begins with asking regulators what is the purpose of banks, to see if we agree.

PS. When will finance ministers dare to ask the regulators The Question?

@PerKurowski ©