The monstrous distortion in the allocation of bank credit to the real economy that regulators do not know they cause

Sir, Tom Braithwaite reports on “Counting the cost to customers of banking regulations” December 3. And he refers to facts such as regulators tightening the standards of capital requirements for banks, for instance against commitments such as those of letters of credit.

But nowhere does he discuss the cost to some customers, some borrowers, of bank regulations that discriminate among the customers. Might it be that he, like the regulators, has not yet understood it?

Let me explain it all to him again.

If there was no risk weighing of Basel II’s 8 percent capital requirements for banks, then the banks would allocate their credit in the real economy, based on who produces the highest risk-adjusted return on eight units of bank capital for each 100 units of loans.

But there is risk weighing in Basel II, and so banks allocate their credit, for instance to the private sector, in terms of:

For those rated AAA to AA, risk weight of 20%, based on who produces the highest risk-adjusted return on 1.6 units of bank capital for each 100 units of loans.

For those rated A+ to A, risk weight of 50%, based on who produces the highest risk-adjusted return on 4 units of bank capital for each 100 units of loans.

For those rated BBB+ to BB-, and those unrated, risk weight of 100%, based on who produces the highest risk-adjusted return on 8 units of bank capital for each 100 units of loans.

For those rated AAA to AA, risk weight 20%, based on who produces the highest risk-adjusted return on 1.6 units of bank capital, for each 100 units of loans.

And so of course those perceived as safer produce the banks a much higher risk-adjusted return on equity than those perceived as riskier.

And that causes banks to lend more than what they should to those perceived as safe and much less, sometimes nothing, to those perceived as risky… like to medium and small businesses, entrepreneurs and start-ups.

And amazingly… the regulators… xxx… do not even understand they are distorting the economically effective allocation of bank credit in the real economy.

What are we to do with them?