Tuesday, April 26, 2016

America "The Home of the Brave" is going down, because of bank regulators' silly/sissy credit risk aversion.

Banks use to decide whom to lend to, based on who offered them the highest risk adjusted interest rates. 

Not any more. Now banks have to calculate what those risk adjusted interest rates signify in terms of risk-adjusted rates of return on their equity. That is because with their risk weighted capital requirements, regulators now allow banks to hold less capital, and therefore be able to leverage more their equity, when engaging with The Safe than with The Risky.

And those perceived, decreed or concocted as belonging to The Safe, include sovereigns (governments), members of the AAArisktocracy and the financing of houses.

And those belonging to The Risky are SMEs, entrepreneurs, the unrated or the not-so good rated, and citizens in general.

And that of course has introduced a regulatory risk aversion that distorts the allocation of credit to the real economy. By guaranteeing “The Risky” will now have too little access to credit, that dooms the economy and the banks to slowly fade away.

But the banks and the economy could also disappear with a Big Bang. That because by giving banks incentives to go too much for The Safe, sooner or later, some safe havens will be dangerously overpopulated, and we will all suddenly find ourselves there gasping for oxygen.

In essence, because of this regulation, banks no longer finance the riskier future; they just refinance the (for the time being) safer past.

How did this happen? There are many explanations but the most important one is that regulators never defined the purpose of the banks before regulating these.

“A ship in harbor is safe, but that is not what ships are for.” John A Shedd, 1850-1926

PS. That also goes for the rest of the world. For instance the Eurozone was done in with it.