The Skewed Risk-Reward Ratio

skewed risk reward ratioTo illustrate the problem of how skewed the risk-reward ratio of banks vs. consumers is you just have to look at today’s all time high in the yield gap between banks’ mortgage rates and the rates banks borrow from the central bank.

This increased yield gap will increase bank profits while at the same time increase the interest burden to the consumer side of the equation. As usual, the banks score another goal on the behalf of the consumers.

So, is it really a problem in a free market that one party wants increased compensation for the increased risk? No.

Unfortunately there is still no such thing as a free market, and it is highly doubtful that the banks should get compensation for increased risk, knowing that the public will take the fall in the event of a default situation.

That is a really skewed risk to reward ratio for banks and consumers, where the consumers have drawn the short straw. This is also referred to as asymmetric risk, which risk expert Nassim Taleb, among others, often warns about.

I do not know which word to choose, laughable or pathetic, when the new president of ECB, Mario Draghi, today said:

“Therefore […] banks should consider restraining dividends and ad hoc compensation to strengthen buffers.”

Please Draghi, if you want some respect, do not use the word “should” nor “consider” in when speaking about economics.

Free markets will always end up doing the right choices, but regulated markets are in the hand of a few politicians armed with only hypothesis in one of the most complex field of sciences called economics.

Note:
I have had some technical difficulties and have not been able to update the blog frequently the last few weeks, but problems are resolved and I am back and track.