My number umpteenth effort to explain to XXX the very bad of current bank regulations.

A “risky asset” yields more, let us say 15%.

A “safe asset” yields less, let us say 5%.

And those yields would be deemed by the market as equal risk adjusted yields.

And market participants would buy those assets according to their needs and risk appetites.

But then came the Basel Committee for Banking Supervision with its risk weighted capital requirements for banks, more risk more equity – less risk less equity, and that completely distorted the allocation of bank credit.

Because now banks could leverage their equity more with safe assets and thereby obtain higher risk adjusted returns on safe assets than with risky assets.

As a result the overall market demand for safe assets increased, and that of risky assets decreased. That “risky asset” yielding 15% before, might now have to yield 16% or more. That “safe asset” yielding 5% before, might now just yield 4% or less.

Is this good? Of course not! Regulators, probably without even understanding what they were doing, altered the free market’s risk assessments; causing dangerous overpopulation of safe havens; and, for the real economy, equally dangerous under-exploration of the risky bays where SMEs and entrepreneurs usually reside. 

The net result of it is:

Crises, like that of 2007-08, resulting from excessive exposures to what was perceived, decreed or concocted as safe, like AAA rated securities and loans to sovereigns (Greece)

Stagnation, resulting from all the stimulus, like that of QEs, not flowing freely to where they are most needed, but only populating more and more the remaining safe havens.

In other words this damn piece of regulation has our banks no longer financing the riskier future but only refinancing the safer past; and so we are doomed to doom and gloom, and to run out of safe havens.

Of course, having set the risk weight for loans to sovereigns at 0% and to We the People, the regulators also introduced, through the backdoor in 1988, a powerful pro-statism tool.

The distortions are not even acknowledged by the regulators, much less discussed.

God help needing pensioners and job seeking youth! God help us all!

PS. If you have understood this and want more details on the greatest regulatory faux pas in history you might want to read the following more extensive aide memoire.

PS. Here are some of my past explanations for dummies.

PS. Today 50% of my constituency, my grandchildren, gets to be 5 years old.