The originally “risky” are being diabolically squeezed

Sir Gillian Tett in “Pipes remain clogged even as liquidity is pumped in” August 7, writes that “now most banks seem unwilling to use spare liquidity to engage in activity that regulators or shareholders might deem risky”. This is not surprising, anything risky requires more regulatory capital, and the banks have more than enough with all their currently outstanding loan and investments that require more capital when they are downgraded, and so even though the banks have liquidity they cannot afford more risky business.

This is placing an excruciating squeeze on the weak and more risky clients of the banks, because even if these are performing much better than the originally “risk-free” banks might choose to liberate capital by getting rid of these exposures without booking losses so as to be able to keep on the books AAAs turned into junk and that if sold would hit the banks harder.

Also let us not forget that the capital requirement for any investment in an AAA rated public instrument is 0%. In all, with their minimum capital requirements for banks based on risk, the regulators have created a monster.