The wrong bank regulation

This is fascinating (for a certain level of fascination).

You know those constant cries about how we\’ve got to have international regulation of the banks to put them back in their boxes?


Walter Wriston\’s 1970s dictum that \”sovereigns can\’t default\” was disproved in the Third World Debt Crisis of the 1980s, but somehow the BIS Committee on Bank Supervision still embraced it when applied to OECD state debts.

Roughly, the risk weights of the main asset classes under Basle I were:
– zero for Zone A (OECD) government debt of all maturities and Zone B (non-OECD) government debt of less than one year;
– 20 percent for Zone A inter-bank obligations and public sector entity debt (e.g. Fannie Mae, Freddie Mac, et al.);
– 50 percent for fully secured mortgage debt;
– 100 percent for all corporate debt.

\”Risk weights\” are how much capital did a bank have to put against a loan? (The purchase of a bond is a loan in this sense). 100% would mean 8% had to be set aside. Just the same as our old friend the reserve ratio in fractional reserve banking.

0% of course means that no capital had to be put aside. Even worse, holdings of those OECD Zone A (and B of short maturity) bonds which, remember are loans (like, to Ireland!) not only needed no capital reserved against them, they themselves counted as capital against further loans of any type!

So the first lesson is that the issue is not how much regulation we have of the banks, nor even whether it is international or not. It is *what* regulation we have of the banks.

The second is we have an answer for Willy Hutton. You know his perpetual complaint that the banks won\’t lend to companies? Well, this is part of the reason why. They can gorge themselves on as much government debt as they like and they\’ve not got to put a single penny of capital towards it. So Geo. Osborne can borrow as much as he wants and poor old BP cannot (well, OK, this would be true if capital reserves were the only influence on such decisions, which they clearly aren\’t, but they do have an influence. These reserve ratios do make it cheaper for governments to borrow and more expensive for companies.)

7 thoughts on “The wrong bank regulation”

  1. But surely this makes sense – a bank owns $50m of US Treausry debt, and you would want it to hold a certain % of that as capital – in what form?

    Tim adds: but, given Greece, Ireland, Portugal, Spain, do you really want the banking system set up so as to insist that no capital at all must be held against soverign, OECD, debt?


    And that holdings of such debt count as capital against other lendings?

  2. I’m the most bullish supporter of the capitalist system you could find in a month of trying and even I know this is fucked into a cocked hat.

  3. Errm, is this news ? Basel I was how many years ago ?

    Basel II went further and allowed muc lower capital weights for numerous classifications of debt provided it was AAA. Which is why the Ratings Agencies suddenly found themselves with a massive conflict of interest when rating bank-generated securities, which did more than anything to accelerate the house of cards.

    Basel III, naturally, is lurching in the opposite direction, and will drive a credit crunch in two years time that makes the 1930s look like a picnic…

  4. To me, reserves should be just that. Of course, liquidity is the point, so the question is, could the Treasury Bonds be liquidated immediately at historic Market rates (ie the numbers the paper was booked as to back the lending), so justifying 0%?

    I am not convinced. At. All.

    To say paper of ANY kind is 100% equivalent when push comes to shove to cold hard M0 sitting in the central bank is delusional.

    It is not a question of “weak” or “light” regulation, but of poacher-led regulation.

  5. Roger – M0 is paper, surely?

    I’m just not sure holding dollar banknotes in a vault against US Treasury 1yr bills make an awful lot of sense.

  6. Matthew, your point would hold if the bank has reserves of t-bills for lent t-bills, but it does not, the t-bills need to be sold and at a suitable price, for M0 to meet the obligation.

  7. I don’t understand what you mean.

    What do you think they should keep in their reserves as capita against their reserves of T-Bills?

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