Wednesday, March 16, 2016

Dr Raghuram Rajan the color of the credit risk weighted capital requirement for banks policy is INTENSE RED

Dr Raghuram Rajan: in “Towards rules of the monetary game” a speech delivered in New Delhi March 12, 2016 during the conference" Advancing Asia: Investing for the Future" said: 

“To use a driving analogy, polices that are generally seen to have few adverse spillovers, and are even to be encouraged by the global community should be rated Green, policies that should be used temporarily and with care could be rated Orange, and policies that should be avoided at all times could be rated Red.” 

And I have a simple question for Dr Rajan: 

What color, Green, Orange or Red would he give the policy of the risk weighted capital requirements for banks? 

That which allows banks to hold much less capital against what is perceived ex ante as safe than against what is perceived as risky. 

That which therefore allows banks to leverage more their equity with what is perceived ex ante as safe than with what is perceived as risky.

That which therefore allows banks to earn higher risk adjusted returns on equity on what is perceived ex ante as safe than on what is perceived as risky.

That which therefore cause banks to create excessive and dangerous exposures to what is ex ante perceived as safe and insufficient exposures to what is perceived as risky. 

That which in real terms means causing the banks to extract the most refinancing much more the safer past abandoning their social responsibility of assisting in the financing of the riskier future. 

That which “has led to the debt overhang” that which makes it more difficult for “new technologies and new markets [to] come to the rescue” 

Dr Rajan asks and answers: 

“Why is there so much of a political need for growth in industrial countries? 

One reason is the need to fulfill government commitments such as debt and social security entitlements. 

Another reason is that growth is necessary for inter-generational equity, especially because the young, who are most benefited from job creation, are the generations that will be working to pay off commitments to older generations. 

A third reason is that, within country, long periods of below par growth can lead the unemployed to become unemployable.” 

Dr Raghuram Rajan, using your driving analogy the color of the policy of risk weighted capital requirement for banks is INTENSE RED, especially for developing countries like India.

PS. Here is the document I presented at the High-level Dialogue on Financing for Developing at the United Nations, New York, October 2007, and titled “Are the bank regulations coming from Basle good for development?” It was also reproduced in The Icfai University Journal of Banking Law Vol. VI No.4, India, October 2008