Bank regulators insisting on playing risk managers for the world, evidences hubris and lunacy is still going strong.

Sir, it is indeed scary reading Brooke Masters reporting on a “Call to harmonise bank risk models”, August 6.

The average risk weight for sovereign corporate and institutional debt that European Banking Authority found in 35 big banks is quoted as being 35 percent with a standard deviation of 12 percent. This indicates how frightening badly capitalized most European big banks are.

In Basel II terms a 35 percent risk weight, applied to a generously defined 8 percent basic capital requirement, could indicate the average banks to be assets to equity leveraged about 35 to 1, and some even 55 to 1 and more.

But even scarier, is reading what EBA suggests. Bank regulators should not be risk-managers for the world and have no business concerning themselves with whether the models banks use to analyze their risk work or not. Their responsibility is to think exclusively in terms of what to do when risk-weights and risk-models do not function adequately. And, in this respect, the last thing regulators should do is precisely what the European Banking Authority calls for, which is “further moves towards harmonized rules for risk models”. That only guarantees to increase the systemic risk of many risk models being wrong at the same time. It is as if regulators have learnt nothing at all from this crisis.

All in all what the article indicates, is the need for a more simple leverage ratio type of capital requirement, which, since applied equally to all assets, makes it therefore more independent of risk models. That would of course also help to reduce the extreme distortions in the allocation of bank credit to the real economy introduced by capital requirements based on perceived risks.