World Bank, more than a “Knowledge” bank, a “Besserwisser” bank, be the “Wisdom” bank I know you could be; or, if that sounds too haughty, at least aspire to be “The Common Sense” bank.

A “Knowledge” bank might think that assets perceived as risky could be risky for banks. A “Wisdom” bank understands that what could be especially risky for banks, and for bank systems, is what is perceived as safe.

A “Knowledge” bank might think that it is great for banks to avoid taking risks.

A “Wisdom” bank knows that the most important function for banks is to take intelligent risks on behalf of society.

A “Knowledge” bank might agree with the Basel Committee’s bank capital requirements based on perceived risks.

A “Wisdom” bank would think much more in terms of not distorting credit allocation, and, if that’s not possible, in terms of capital requirements for banks with a purpose, like on perceived chances of fostering human and natural capital wealth

A “Knowledge” bank, if it has to distort the allocation of bank credit, might agree with bank capital requirements against sovereigns based on credit ratings.

A “Wisdom” bank, in such a case, would much more prefer to base the bank capital requirements on a good governance index.

A “Knowledge” bank might say: “We know it all”. A “Wisdom” bank, would understand “We know Jack shit!”

Or, if aspiring to becoming the “Wisdom bank” sounds too haughty, the World Bank it should at least aspire to be “The Common Sense” bank.

"God make us daring!"

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.

Friends, if you ever get a chance to talk with a bank regulator ask him this, and then you’ll know they don’t know

Sir, by using risk weighted capital requirements you allow banks to leverage assets differently, something which influences differently the banks' risk-adjusted returns on equity. Don’t you think this could dangerously distort the so vital efficient allocation of bank credit to the real economy?

Sir, we see you have set a risk weight of only 20% for private assets rated AAA to AA; and one of 150% for those rated below BB-. Do you really believe that what is rated below BB- is more dangerous for the bank system than what is rated AAA to AA?

And when you then see him evading the issue by answering something else, then you have the right to know, as I do, that he and his colleagues have no idea about what they are doing… and are running scared people will find out.

PS. If you want further details on the bank regulatory monstrosity you can go HERE

The Basel Committee for Banking Supervision successfully staged a cloaked global statist coup

Supposedly to make our banks safer, in 1988, with the Basel Accord, Basel I, the Basel Committee for the purpose of setting the capital requirements for banks, declared the risk weight of the “safe” sovereign to be zero percent, and that of “risky” not-rated citizens, We the People, to be 100 percent.

That meant banks needed to hold much less or no capital at all, when lending to the sovereign than when lending to citizens; which meant banks could leverage their equity and the support they received from society (taxpayers) much more when lending to the sovereign than when lending to citizens; which meant banks would earn higher risk adjusted returns on equity when lending to sovereigns than when lending to citizens; and which meant banks would favor more and more lending to the sovereign over lending to the citizen. And the SMEs and the entrepreneurs basically here represent the “not-rated citizens”.

There could be some discussion on whether lending to sovereigns represent less risk than lending to SMEs and entrepreneurs. I do not believe so. Banks do not create dangerous not diversified excessive exposures to SMEs and entrepreneurs; and, at the end of the day, the sovereign derives all its strength from its citizens. 

But what cannot be discussed is that implicit in these regulations, is the belief that government bureaucrats use bank credit more efficiently than SMEs and entrepreneurs, and that is pure and unabridged dumb runaway statist ideology to me.

For a starter, without this kind of regulatory subsidy, the Greek sovereign would not have been able to obtain so much credit. 

And then, without this kind of regulatory tax on private initiative, Greece will never be able to work itself out of its current predicament.

And the world keeps mum on this!

We must allow our banks to be banks again.

Basel risk-weights: Sovereign (Monarch) 0%, AAArisktocracy 20% and citizens 100%: And the world said nothing!

With the Basel Accord of 1988 (signed one year before the Berlin wall fall) regulators, for the purpose of setting the capital requirements for banks, assigned a 0% risk weight for loans to the sovereign and 100% to the private sector. Some years later, 2004, with Basel II, they reduced the risk-weight for loans to those in the private sector rated AAA to AA to 20%, and left the unrated citizens with their 100%.

That has introduced a considerable regulatory subsidy for the bank borrowings of the infallible sovereign (government bureaucrats) and of those of the private sector deemed almost infallible. And that has severely taxed the access to bank credit, of those deemed as risky, like SMEs and entrepreneurs.

That de facto means that bank regulators believe that government bureaucrats know better what to do with bank credit than citizens.

And the world said nothing! What's wrong? Have all gone statist?

Stock markets and the real economy, c’est pas la meme chose.

Do not confuse the strength of the stock market with the strength of the economy.

The strength of the stock market can have to do only with the strength of owning what little there is to own. 

If central banks fueled share buybacks continue, we might end up with the strongest of stock markets, and the weakest of the real economies.