Wednesday, June 3, 2009

The financial discrimination of development

What would the world say if besides the costs of getting water to the driest areas in the world the driest area would have to pay a tax for the water being shipped there? That is exactly what is happening in the financial world with a de-facto arbitrary regulatory taxation of risk. Yet, not a single word on it appears in any pre-statements or background papers to the United Nation´s conference on the world financial and economic crisis and its impact on development, now re-scheduled June 24-26, 2009.

The Basel II: International Convergence of Capital Measurement and Capital Standards of June 2006 in its Standardised Approach requires a bank to hold the following minimum $ equity for each 100 dollars lent by a bank to a sovereign country, depending on the credit rating of that sovereign.

AAA to AA- = $0
A+ to A- = $1.6
BBB + to BBB- = $4
BB + to B = $8
Unrated = $8
Below B- = $12

And I guess you all know how expensive bank equity is, especially now.

Since clearly the lower rated sovereigns will anyhow have to pay a market rates which are considerably higher than what the better rated sovereigns need to pay, it is clear that these differences in capital requirements imply an additional arbitrary tax on capital and that subsidizes anything better able to dress up as risk-free and penalizes anything expected to be perceived as more risky.

Some could argue that this does not amount to any discriminatory protectionism since these criteria are applied across the whole globe but that argument ignores the fact of how the perceived riskiness is unequally distributed around the globe.

This financial arbitrary discrimination against risk and that is present in the minimum capital requirement for bank established by the Basel Committee and that cover all public and private bank finance makes it not only more expensive for capital to go where they could are most needed but they also falsely induce them to go where they should not.

As an example of the above suffices to see how two trillions of dollars, over a period of less than three years, was because of its AAA ratings diverted to the useless financing of a housing boom in the US, instead of for instance financing the creation of sustainable decent jobs; the elimination of many infrastructure bottlenecks that exists in developing countries; or the adaptation and mitigation efforts that climate change threat requires. Two trillion dollars is most certainly more than all the financing provided by all the development banks over all the years.

In fact the current crisis from which so much suffering will result is a direct consequence of the regulatory authorities arbitrary intervening in the risk allocation mechanism of the market… in favor of what a small and incestuous group of bank regulators from some developed countries felt like favoring. Well now those developed countries are not so developed… but this is clearly not the way we should go in order to reduce inequalities.

Friends in the development community, I ask, how long will you ignore this fundamental issue?