Support of SME is In the Role of Central Banks

I have on several occasions highlighted many of the problems with the present regulatory platform for the financial industry, in particular the Basel Framework soon on its third version. In general I have no problem with capital requirements and risk management and that we need regulation for it. However it has to come from the correct perspective. The Basel Framework was created in the 80-ties during deregulation of the financial markets, mainly the credit markets, which came as a natural consequence of president Nixon abolishing Bretton Woods in 1971.  

The perspective of the Basel Framework:

1. Banks shall be protected at all costs. No banks shall be able to default. There shall be no run on banks.

2. Corporate lending is dangerous and therefore shall be restricted in the banks' balance sheets. 

3. Sovereign risk and real estate mortgage is very low risk and should therefore be incentivized for the banks to invest in.

What have we seen:

1. Banks do go bust. There are still run on banks and financial institutions, e.g. Lehmann Brothers. It is not possible to regulate away bad management. We also saw big flaws in the Basel risk management procedures which did not consider liquidity risk for instance.

2. Corporates have been pressed out to the credit markets outside of the banking system. SME (Small and Medium Sized Enterprises) can only borrow very small parts of the needs from banks. Most lending requires owner's guarantee and/or mortgage of their houses.

3. Banks balance sheets explode on sovereign debt and real estate mortgages. Pretty good bubbles no doubt.

The problem is that the SME market provides most money and employment in the society but they are discriminated by the Basel Framework. This should be a major concern for the central banks and governments. Instead they push for Basel version III. 

Many scream for regulation. But the regulation has to have the correct perspectives otherwise they become counter productive. I would say that the bubbles we have seen during the past 20 years many times have been fuelled by the Basel Framework.