August 08, 2014

Prudence is ok. But prudence on top of prudence is very dangerous too!

Sir, William Rhodes holds that “Without prudence as a value we are all at risk” August 8. Absolutely, that is only as long as we are prudent when being prudent. Let me give you the mother of examples about what I mean.

Bankers already looked at credit risks when deciding interest rates, amounts of exposure and other terms of their financial assets. And they did so in a quite risk adverse way; if we remember Mark Twain’s saying “A banker lends you the umbrella when the sun shines and wants it back when it looks like it is going to rain”.

But then came the regulators and, in the name of their prudence, set also the capital requirements for banks based on the same perceived credit risks… something which suddenly allowed banks to earn much higher risk-adjusted returns on equity when lending to “The Infallible” than when lending to “The Risky”… and which of course resulted in distorting the allocation of bank credit in the real economy.

And so if we begin loading prudence on top of prudence, especially on top of the same prudence, that is when we enter into that Roosevelt territory of having nothing to fear as much as fear itself.

These nanny regulators from Basel, who basically force bankers to eat broccoli when they eat spinach and reward them with ice cream when eating chocolate cake, have now turned our economies into obese monsters, with none of the muscles provided by credits to the risky medium and small businesses entrepreneurs and start ups.