Thursday, June 14, 2012

The Western World, as we know it, is unintentionally being assassinated by Basel bank regulators

If a banker has two types of clients the absolutely not risky and the somewhat risky he will set the interest rates that makes it indifferent for him who he lends to. 

If then that indifference rate of the not-risky is allowed by the regulator by means of differentiating the capital requirements, to be much more leveraged than the indifference rate of the risky, three things will happen: 

First and foremost the banker will concentrate on lending to what is officially perceived as not risky and provides the highest expected risk adjusted return on equity. 

Second, he might even lower the interest rates when lending to the officially perceived as not risky, since he has room for doing that and still produce a risk-adjusted satisfactory return on equity. 

Third, he will ignore the officially perceived risky, that is unless these accept to pay an even higher interest rate. 

The final outcome of the system will be obese bank exposures to what has or is officially perceived as not risky and anorexic exposures to what is officially perceived as risky, like to small businesses or entrepreneurs… In other words… the current crisis.