Friday, July 31, 2009

Capital requirements for banks could be based on a “credit risk - credit purpose” matrix

On July 29 2009, in Venezuela, the financial regulator, Sudeban, issued a normative by which the risk weights used to establish the capital requirements of the banks were lowered to 50%, when banks lend to agriculture, micro-credits, manufacturing, tourism and housing. As far as I know this is the first time when these default risk-weights and which resulted from the Basel Committee regulations, are also weighted by the purpose of the loan.

The way it is done Venezuela lacks a lot of transparency and it could further confuse the risk allocation mechanism of the markets (though in Venezuela that mechanism has by other means already almost been extinguished) but, clearly, a more direct connection between risk and purpose in lending is urgently needed.

In this respect the Venezuelan regulator is indeed poking a finger in the eye of the Basel regulator who does not care one iota about the purpose of the banks and only worry about default risks and, to top it up, have now little to show for all his concerns.

I can indeed visualize a system where the finance ministry issues “purpose weights” and the financial regulator “risk-weights” and then the final weight applicable to the capital requirements of the banks are a resultant of the previous two.

Does this all sound like interfering too much? Absolutely, but since this already happens when applying arbitrary “risk weights” you could also look at this as a correction of the current interference.