This September 2016, it will be 30 years since regulators, scared of the climb, declared our economies should peak. Thus started the shift from emphasis on quality of bank assets essentially to equity and those specified assets considered very low risk or risk-free which could be accounted as equivalent to equity.
"On September 2, 1986, the fine cutlery was laid once again at the Bank of England governor's official residence at New Change... The occasion was an impromptu visit from Paul Volcker... When the Fed chairman sat down with Governor Robin Leigh-Pemberton and three senior BoE officials, the topic he raised was bank capital...
At dinner the governor's hopes had been modest: to find areas of sufficient convergence of goals and regulatory concepts to achieve separate but parallel upgrading moves...
Yet the momentum it galvanized... produced an unanticipated breakthrough of a fully articulated, common bank capital adequacy regime for the United States and United Kingdom. This in turn catalyzed one of the 1980's most remarkable achievements - the first worldwide protocol on the definitions, framework, and minimum standards for the capital adequacy of international active banks...
They literally wiped the blackboard clean, then explored designing a new risk-weighted capital adequacy for both countries...
It included... a five-category framework of risk-weighted assets... It required banks to hold the full capital standard against against the highest-risk loans, half the standard for the second riskiest category, a quarter for the middle category, and so on to zero capital for assets, such as government securities, without meaningful risk of credit default."
The rules of banking were suddenly changed ...
And that suddenly meant that banks were able to leverage equity much more with what was perceived, or deemed by regulators, as safe, than with what was perceived as risky.
And that of course meant banks would earn higher expected risk-adjusted rates of return on equity on what was perceived as safe than on what was perceived as risky.
And that meant banks would stop lending to the risky future and just keep to refinancing the safer past.
The bank regulators, scared of more climbing, had thus declared that the Western Civilization had reached its peak. No more risk-taking!
The Basel Committee for Banking Supervision, with the Basel Accord of 1988, concocted Basel I and in 2004 Basel II... and they are now in Basel III... and it has all been going down down ever since it started. The liquidity injected byTARPs, QEs and fiscal deficits, and which generate temporary illusions of growth - monetary obesity - cannot reach those who could best produce sturdy growth, the "risky" SMEs and entrepreneurs.
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