How do you subsidise something without spending any money? If you have a tame banking system you control, it’s simple — use banks’ money instead.
That’s a well established approach in certain corners of the banking markets. Sovereign bonds are 0% risk-weighted, giving banks a strong incentive to load up the balance sheet with government paper. If that wasn’t enough, the US has now proposed to exempt them from the leverage ratio as well.
Lending money to the government is sufficiently important politically that even the leverage ratio, supposed to act as a simple, ungameable backstop to flighty and complex risk-weighted asset figures, is being subverted for the purpose.
European governments have also come together to agree a capital subsidy for lending to small and medium-sized enterprises, which, it seems widely agreed, are underserved by existing bank capital rules.
A loan to a SME benefits from the “supporting factor” of 0.74 — in layman’s terms, it requires 26% less capital to support it than a loan of equivalent risk to a larger firm.
Banks are not using this break as aggressively as they might (one suspects that various national regulators of more sober cast than their political masters might raise disapproving eyebrows). But the idea that risk disappears as long as lending is directed to a politically palatable sector remains on the books.
Subsidised SME lending could easily end up going to finance buy-to-let mortgages or commercial real estate — large portions of European SME lending are in effect real estate credit. The kaleidoscope of high growth proto-Googles that would flourish in Europe if only bank loans were cheaper is largely a figment of political imagination.
Now it might be the turn of green finance, and it is an equally dangerous idea. Green bonds and loans, like SME finance, rest on worryingly slippery foundations, even if regulations are redrawn to create an official EU standard for the asset class. Green bonds can be issued by oil companies or coal-burning utilities; green bank bonds can deliver no additional green funding whatsoever, but can simply reflect rebranding or data collection exercises.
Add to this asset class an incentive to game the system, such as a potential cut in capital requirements for sneaking inside a “green bond definition”, and it could quickly lead to standards being debased, as issuers with little genuine interest in showing off sustainability start getting involved in the market.
To sneak in a subsidy through banking regulation, too, shows a lack of political courage.
There are plenty of good reasons to subsidise a faster transition to green energy and infrastructure, and there might even be reasons to subsidise SME lending. But if that is true, have the debate in the open.
Commit public funds directly, in a transparent fashion, to support whichever causes are deemed worthy.
If capital requirements for European banks could be cut by 25% without harm or risk — then best to go right ahead and cut them.
If they’re at a given level to protect society from the risk of bank failure, then cutting them for favoured causes is wrong and irresponsible. Banking regulation is the wrong tool to use to direct capital to whatever politicians want to fund — it should be about measuring risk, not playing politics.