Thursday, April 2, 2015

Reserve Bank of India: This is not so smart of you. In fact it is quite dumb.

The Reserve Bank of India has decided that Basel III standards for capital (equity) and liquidity shall apply for lenders operating in the country.

That means that in India they will keep applying the regulatory pillar of more-perceived-credit-risk-more-equity and less-perceived-credit-risk-less equity.

Which means lenders in India will be able to leverage their equity, and the support they receive from taxpayers, much more with net margins collected on loans to those perceived as “safe” than on loans to those perceived as “risky”.

Which means that lenders in India will make much higher risk adjusted returns on equity when lending to those perceived as “safe” than on loans to those perceived as “risky”.

Which means that lenders in India are doomed to lend too much at too low rates to those perceived as “absolutely safe” and too little at too high rates to those perceived as “risky”, like the SMEs, entrepreneurs and start-ups. 

That, for a developing country, does not sound so smart, in fact it is quite dumb.

And all this happens probably only so that some Indian regulators can show off in front of their colleagues in the developed countries.

But, even for developed countries that Basel pillar is dumb. It is like if a young professional setting up his retirement account he tells his investment manager: “I will pay you much higher commission on earned returns from investments in what is thought safe than what I will pay for the case of investments in what seems risky”. That will lead to excessive risk aversion and probably cause him a very poor retirement income.

Have India and other developing countries completely forgotten that risk-taking is the prime oxygen of any development?

Developing countries have clearly forgotten what made them develop… and have now, with these regulations that so odiously discriminate against the fair access to bank credit of “the risky” have call it quits, and begun un-developing.

And all for nothing since never ever do major bank crises result from excessive exposure to what is perceived as risky, these do always, no exceptions, result from excessive exposures to something perceived as absolutely safe, but that ex post turned out very risky.

PS. From some things I have heard about India, and from some experiences I have had in my country, Venezuela, it would seem that equity requirements based on closeness-to-borrower ratings could make some sense. The closer the bank, and its board are to the borrower, for instance they could be siblings, the higher the equity requirement.