April 11, 2015

What correlation Andy Haldane? There is not even a regression between perceived risk of assets and major bank crisis.

Sir, Tim Harford mentions that “Andy Haldane, chief economist of the Bank of England, recently argued that economists might want to take mere correlations more seriously”, “Cigarettes, damn cigarettes and statistics” April 11.

I agree and a good place to start would be to even establish whether a correlation exists. Currently regulators have decided that what is perceived as safe from a credit point of view, shall require banks to hold much less equity than what is perceived as risky. That introduces serious distortions in how bank credit is allocated to the real economy.

I presume such equity requirements could only be justified if these helped to make the banks so much safer in such a way, that the benefits that would bring to the economy were larger than the possible negative effects of an inefficient credit allocation. Personally I do not see how that could be.

But no such analysis backs the credit risk weighted equity requirements that currently form the pillar of bank regulations.

Much worse yet, there is not even a regression between the ex ante perceived credit risks of bank exposures and major bank crisis… so there is not even a correlation to look at.

And so yes, Andy Haldane should run that regression, and take the resulting correlation seriously, even if as a regulator he then must eat plenty of humble pie.

I say so because starting from the angle of causation, I expect the correlation Haldane would find would indicate that the safer a bank asset is perceived ex ante, the more danger to the banking system it represents. In other words a 180-degree different relation than what bank regulators actually assume.

Why is it so hard to have regulators following the precept of do no harm?


PS. Follow my adventures battling the Basel Committee for Banking Supervision (and the Financial Stability Board)