June 12, 2016

Europe - Eurozone stands no chance against the regulatory manipulation of how bank credit is allocated to its real economy.

Sir, Timothy Garton Ash opines “that rushing into a deeply flawed monetary union — bad design, too large and diverse a membership — was the biggest single mistake in the history of European integration”, “The fading of Europe is a result of both its failures and successes” June 11.

Few weeks before the launch of the euro I wrote an Op-Ed in Caracas titled “Burning the bridges in Europe”. I believe its content should have earned me a right to opine on what then has happened.

But what I had no idea about, since I then had nothing to do with it, was of the route bank regulators had initiated with their Basel Accord of 1988 (Basel I). In it the concept of risk-weighted capital requirements was introduced, and the risk weight for the sovereign (the government) was set at zero percent while that of the citizen was fixed at 100 percent.

Risk weighted capital requirements for banks might sound reasonable as making banks safer… though they really don’t! But, since they allow bank equity to be leveraged differently with different assets, these absolutely distort the allocation of bank credit to the real economy… and that distortion was completely ignored… and still is.

In essence it meant that since banks could leverage equity more with loans to the governments than with loans to the citizens, they would therefore earn higher expected risk adjusted returns on equity on loans to the government than on loans to the citizens. And that meant that the government bureaucrats were de-facto deemed to use bank credit more efficiently than the private sector.

And of course, such statism, introduced by the bathroom window, had to condemn Europe (and the rest), with or without the euro.

In a letter published by FT in November 2004 I asked: “How many Basel propositions will it take before they start realizing the damage they are doing by favoring so much bank lending to the public sector?

And in June 2004, with Basel II, and though in that case I had been able to protest strongly but uselessly against it, the regulators also introduced risk weighting for the private sector. The risk weights ranged from 20% to 150%, depending on credit ratings; which discriminated in favor of “the safe” privates against “the risky” privates.

And of course, such credit risk aversion, introduced by the bathroom window, had to condemn Europe (and the rest), with or without the euro.

In November 2011 I explained it all in much more detail in “Who did the Eurozone in?”

But, for instance the absolute silence of FT about my many warnings about the regulatory distortion of the allocation of bank credit to the real economy, seems to indicate this issue is of little interest… I wonder why?

For me the risk aversion of Basel regulations, which implies not daring to climb higher because of being afraid of losing what its got, means that Europe (and the rest) have capitulated… and that is a mistake that at least is going to cost all our young ones much more than the possible euro mistake.

@PerKurowski ©