September 24, 2009

The regulators, thinking themselves Gods, misinform the markets and the experts

Sir, when is FT going to do an “Analysis” on what the risk-weights signify for the reported bank-leverages. The sooner the better, since that could save many experts (including some of your own) from making fools out of themselves.

Andrew Kuritzkes and Hal Scott in “Markets are the best judge of bank capital” September 24 quite correctly state that “We need to complement regulation with more effective market discipline. This requires better information”.

But, in their discussion of bank leverage and even though they mention the possibility that “capital requirements are imperfectly linked to bank-risk taking” they seem unable to realize that the reason the capital requirements relative to risk-weighted assets turned out to be so faulty, had nothing to do with the basic 8 percent level established, and all to do with the risk-weights used.

The use of arbitrarily set regulatory risk weights, like those which give only a 20% weight to an AAA asset misinformed the market and experts like Kuritzkes and Scott, making them all unable to understand what was going. The sooner we free ourselves from regulators playing Gods calibrating risks, as if they possess the whole truth on risk, the better.