A letter to finance and development ministers of developing and developed countries.

Do you finance and development ministers believe that it is the purpose of your commercial banks to help nurture those small businesses and entrepreneurs that create new jobs while they become large enough to have credit ratings and access to capital markets?

Do you finance and development ministers believe that bank regulations are not there in order to increase the returns of banks in areas that are perceived as having low credit default risks and therefore already much favored by the markets?

Do you finance and development ministers believe that the banks should work as bridges directing capitals to generate growth and jobs and not just serve as tolls to assure profits to the financial sector?

Do you finance and development ministers believe that a 450 pages long “Financial Sector Assessment handbook”, published in 2005 by the World Bank and the International Monetary Fund, should contain more than 10 pages and the suggestion of only “express a general view” on the issue whether the financial services are adequately serving the needs of the real economy?

Do you finance and development ministers believe that there are other risks in the world much more important for the future wellbeing of your country than the risks of banks defaulting?

Do you finance and development ministers believe that the debt-sustainability framework should be about more than just sending the message that debts are good as long as they are sustainable?

Do you finance and development ministers believe that after a crisis like the current one exploded, regulators would be busy revising their regulatory paradigm instead of digging us even deeper in the hole we’re in?

If you do believe so you would perhaps want to contact someone like me.

Otherwise keep on doing what the Basel Committee and the Financial Stability Board and the International Monetary Fund and the big global banks want you to do.

Of course, much better than just contacting someone like me would be if you could contact the World Bank directly on the issue of banking and development. Unfortunately, ever since the Bank-Fund Financial Sector Liaison Committee was set up in 1998, the experts in the World Bank, in the name of harmonization, have been very much silenced by those in the Fund who, come what may, can only dream about of financial stability.

Best regards

Per Kurowski

A former Executive Director of the World Bank (2002-2004)

The Basel Committee makes small businesses and entrepreneurs pay much more for their bank credit

When compared to a regulatory system with equal bank capital requirements for all type of assets, the Basel system that imposes different requirements based on some arbitrary risk-weights related to credit ratings, implies that a small business needs to pay about 2 percent (200 basis points) more in interest rates in order to stay competitive when accessing bank credit.

Suppose a bank feels that the normal risk premium should be .5 percent for an AAA rated company and 4 percent for a small business. If the bank was required to have 8 percent for both assets and could therefore leverage itself 12.5 to 1, then the expected before credit loss margin on bank equity for the AAAs would be 6.25% and for the small business 50%, a difference of 43.75%.

But, since the bank is allowed by Basel to hold only 1.6 percent against AAA rated assets, which implies permitting a leverage of 62.5 to 1, the previous margin 6.25% margin for AAA assets becomes a whopping 31.25%, which now implies a difference in the margins on equity of only 18.75% when compared to that generated by the small businesses.

In order to restore the initial required competitive margin difference of 43.75, now only 18.75% the small businesses will have to generate for the banks an additional gross margin of 25 percent, which, divided by the 12.5 to 1 leverage allowed for their class of assets, comes out to be the additional 2 percent in interest rate referred to.

Of course a complete analysis would require considering many other dynamic factors, but those would only help to fog the basic truth that our regulators are discriminating against those the banks are most supposed to serve.

What will it take for the regulator to understand that this is no minor problem, especially when so much of any job recovery lies in the hands of small businesses and entrepreneurs?

What will it take for the regulator to understand and admit that the regulatory discrimination in favor of the AAAs caused the current financial crisis?