What if banks could earn their highest expected risk adjusted returns on equity where they are most needed, like in Blackpool?

Sir, I just read Sarah O’Connor’s harrowing description of what is going on in Blackpool “Left behind: can anyone save the towns the economy forgot? FT Magazine, November 16.

It all sounds like Blackpool belonging to what we read more and more about, that termed as scrap land or junk land.

Sir, can we really afford to abandon those places to who knows who or to what knows what? If we do so what truly bad (or good) things could brew there? We might have some unexplored tools to help stop that or at least not to worsen it.

For instance, our banks, by means of the risk weighted capital requirements for banks are currently allowed to leverage more their equity when lending to what is perceived as safe than when lending to what is perceived as risky; and so banks earn higher expected risk adjusted returns on equity on what is perceived as safe than on what is perceived as risky; so banks, naturally, lend much more to what is perceived as safe than to what is perceived as risky.

That is doubly stupid. First because why would you like to help those who are perceived as safe and that because of that already have more access to credit to have even more access to bank credit? Likewise why would you like to cause those who are perceived as risky and who because of that already have less access to credit to have even less access to bank credit? In other words “safe” London earns banks higher ROEs than “risky” Blackpool.

And secondly because from a bank stability point of view you are acting against what history proves, namely that those perceived as safe are a hundred times more dangerous to bank systems than those perceived as risky. In other words London is riskier to the bank system than Blackpool.

So let us suppose we instead based those risk weighted capital requirements, and the distortion they produce, on where we think bank credit could most be needed or most productive. Then we could perhaps arrange it in such a way that a bank lending to an entrepreneur in Blackpool would be allowed to leverage more than when lending to an entrepreneur in London. And then Blackpool could have a better chance to regain some of its former luster or at least not lose it all.

@PerKurowski