Is the US dissociating from Basel banking rules?

I was left a little bewildered by this recent FT article:

US lending to businesses is reaching record levels but banks are privately warning that the activity should not be seen as evidence of an economic recovery.

Despite Basel rules that favour mortgage lending over business lending, and business lending struggling in Europe and the UK as a result, have US banks found the trick to bypass those rules or decided not to maximise their profitability? Is the US special?

First, let’s look at the data:

US lending BaselThe first thing that comes out of this chart is the massive trend change from the end of the 1980s onwards. What happened at that time? Basel 1 rules were introduced, making it more expensive in terms of capital utilisation to lend to corporates than for real estate-related purposes. Basel is the turning point. Ex-ante, corporate lending volume used to be slightly larger than mortgage lending for decades. Ex-post, house lending became the primary channel of credit growth, by far.

Something happened during the crisis: from end-2010 until now, the differential between the total volume of mortgage lending and the total volume of corporate lending tightened to USD1.9Tr. Surely this doesn’t fit my story that Basel rules introduce massive distortions of the lending channel. I have to admit that my knowledge of the US market is limited. Nevertheless, there is a possible explanation.

First, the tightening remains moderate: ‘only’ USD200Bn, or 9.5% of the original differential. The tightening arose from a strong recovery of business lending from early-2011 onwards (following a sharp fall during which the differential actually widened), whereas mortgage lending remained flat.

Second, risk-weights on residential and commercial real estate lending actually increase when the sector suffers and property prices collapse. The US experienced a large fall in both residential and commercial real estate prices. As defaults on those mortgages and foreclosures soared, risk-weights increased.

It is then very likely that, from a capital utilisation point of view, lending to businesses was as profit-maximising – if not more – as extending credit for real estate purposes. Indeed, daily corporate bankruptcies started normalising from early 2010, whereas house prices continued declining until mid-2012.

It also looks like much of this new corporate lending has been driven by large corporations (for acquisitions and share buybacks), which are less capital intensive for banks (especially at the moment, as many of them are sitting on large piles of cash, USD1.6Tr according to Moody’s, and growing at rapid pace – 12% p.a.). Moreover, the latest data seems to indicate that real estate lending is making a comeback.

At the end of the day, it looks a little premature to say that US banks have found the way to bypass Basel to fund industrial companies and SMEs…

Nevertheless, there is some glitter of hope. The UK regulator PRA warned banks that they may have to increase risk-weights on mortgage lending, hence increasing the amount of capital necessary to fund those loans and making them slightly less attractive to maximise profitability, relatively to other asset classes. This is ironic though. Risk-weights have been introduced and encouraged by regulators over the last twenty years, and still very few of them seem to understand the inherent capital allocation distortion they lead to…

I had a dream: that RWAs and Basel’s economically distortive rules were abolished and we were going back to the pre-1988 consensus of similar industrial and mortgage lending volume. Perhaps we would witness fewer housing bubbles and more economic growth*… But that’s just a dream.

* And be spared of ignorant ‘secular stagnation’ ideas that ignore the economic dynamics at the micro level…

 

PS: reduced blogging activity over the past 10 days due to work and travel… I’ll try to catch up soon.

Advertisements

Tags:

4 responses to “Is the US dissociating from Basel banking rules?”

  1. viennacapitalist says :

    Excellent Post, the chart is telling. I would probably look into liquidity costs as a a reason why lending has contracted somewhat on a relative basis. Pre-crisis banks did not even price the liquidity risk of a 25-year mortgage – this certainly has changed since the beginning of the crisis and would affect mortgage lending disproportionally…Also the effect should be higher for the US than, say, Germany because its mortgage market is more wholesale funded…

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Marginal REVOLUTION

Small Steps Toward A Much Better World

Dizzynomics

Finding patterns in finance, econ and technology -- probably where there are none

Alt-M

When financial markets spontaneously emerge through voluntary human action

Pumpkin Person

The psychology of horror

Uneasy Money

Commentary on monetary policy in the spirit of R. G. Hawtrey

Spontaneous Finance

When financial markets spontaneously emerge through voluntary human action

ViennaCapitalist

Volatility Is The Energy That Drives Returns

The Insecurity Analyst

When financial markets spontaneously emerge through voluntary human action

Sober Look

When financial markets spontaneously emerge through voluntary human action

Social Democracy for the 21st Century: A Realist Alternative to the Modern Left

When financial markets spontaneously emerge through voluntary human action

EcPoFi - Economics, Politics, Finance

When financial markets spontaneously emerge through voluntary human action

Coppola Comment

When financial markets spontaneously emerge through voluntary human action

Lend Academy

Teaching the World About Peer to Peer Lending

Credit Writedowns

Finance, Economics and Markets

Mises Institute

When financial markets spontaneously emerge through voluntary human action

Paul Krugman

When financial markets spontaneously emerge through voluntary human action

Free exchange

When financial markets spontaneously emerge through voluntary human action

Alt-M

When financial markets spontaneously emerge through voluntary human action

Moneyness

When financial markets spontaneously emerge through voluntary human action

%d bloggers like this: