Friday, July 10, 2015

Prioritizing the financing of residential property over the financing of job creation is not the smartest thing to do

Based on Basel II’s standard capital requirements for banks, these are required to hold 2.8 percent in capital when lending secured by mortgages on residential property and 8 percent when lending to SMEs and entrepreneurs. 

That means that the adjusted for risk net margin paid by a residential borrower can be leveraged 35 times by the bank (100/2.8), while the same margin can only be leveraged 12.5 times (100/8) if paid by SMEs and entrepreneurs.

And that means banks can obtain much higher risk-adjusted returns on equity when lending secured by mortgages on residential property than when lending to SMEs and entrepreneurs. 

And that means that banks will find it much more interesting to finance residential property than to finance those who can help to create the jobs to help residential mortgages and utilities to be serviced.  

That definitely sound skewed the wrong way. If I was the regulator I would much rather prefer banks financing more the creation of jobs, so that people could better afford to buy their homes with less financing… but that’s just little me.

“But building homes creates jobs?” Indeed, but once everyone has a home, and a mortgage to service, which diminishes their available income, where are our grandchildren to work?