August 07, 2014

There are two entirely different kinds of risks. Investing in “risky”, and excessive investment in “safe”

Sir, Tracy Alloway reports that, as a result of “low volatility” which sets off ‘feedback loop”, “Banks warn of ‘excessive’ risk taking” August 7.

Excessive risk taking comes in two forms. Investing in something ex ante perceived as risky, and the most dangerous one, investing excessively in something, ex ante, perceived as “absolutely safe”.

It is important to make that distinction because while other investors might be running more of the first kind of risk, banks, especially because of risk-weighted capital requirements, are much more exposed to the second kind of risk.

For the society the second kind of risk is of course much more dangerous, since excessive investments in what is perceived as “absolutely safe” will take us nowhere.