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Should we prohibit divergent perceptions of credit risk? No and yes!

Wednesday, March 6, 2019 10:05

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Sir, Martin Wolf writes: “the spectres of sovereign default and “redenomination risk” — that is, a break-up of the eurozone — may re-emerge. In a recent paper, Marcello Minenna of Con-sob (Italy’s securities regulator) argues that divergent perceptions of credit risk across member states reinforce divergent competitiveness in goods and services. This puts businesses in peripheral countries at a persistent disadvantage, which becomes worse in times of stress.” “The ECB must reconsider its plan to tighten” March 6.

So should we prohibit divergent perceptions of credit risk?

Absolutely no! The existence of divergent perceptions of credit risk is crucial for an effective allocation of credit.

Absolutely yes! Bank capital requirements based on divergent perceptions of credit risk guarantees an inefficient allocation of credit.

The truth is that businesses in peripheral countries are less at disadvantage for their countries being perceived risky, than for the regulators, or other authorities, considering that there are others much safer. The risk weight for the Italian sovereign, courtesy of the EU authorities is 0%, while the risk weight of an Italian unrated entrepreneur is 100%. Need I say more?

Wolf opines, “The painful truth is that the eurozone is very close to the danger zone [as] the spectres of sovereign default and ‘redenomination risk’ — that is, a break-up of the eurozone — may re-emerge”. Indeed and the prime explanation for that is precisely the 0% risk weights assigned to its sovereigns, those de facto indebted in a currency that is not denominated in a domestic (printable) currency.

We’ve just celebrated the 20thanniversary of the Euro. The challenges its adoption posed were well known. What has EU done to really help confront those challenges? Very little to nothing! In truth, with its Sovereign Debt Privileges, they have managed to make it all so much only worse. Sir, considering that, for someone who truly wanted and wants the EU to succeed, it is truly nauseating to see the daily self-promoting tweets from the European Commission.

@PerKurowski

Source: http://teawithft.blogspot.com/2019/03/should-we-prohibit-divergent.html

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