Bank regulators make sophisticated remarks about the need of countercyclical regulations and design pro-cyclical ones.

Sir, I refer to Joe Leahy’s “Rating agency pressure on BTG Pactual” November 27.

Downgrading… depending on whether it crosses some regulatory thresholds, could mean banks are required to hold more capital against loans assets so affected. Were it to happen, this could, in a pro-cyclical fashion, only help to increase the resulting problems.

And what would usually trigger such a credit degrading? Mostly some unexpected events, like in this case the arrest of BTG Pactual’s chief executive, André Esteves.

And this evidences, for the umpteenth time, the dangers with using ex ante perceived expected credit risks to define the capital banks should hold against unexpected losses.

When the outlook is rosy and so many could be perceived as safe then the capital requirements go down, so bank can leverage even more, so bank can give even more credit, and everything will look even rosier.

When the outlook is darker and many could be perceived as risky, then the capital requirements go up, so bank can leverage less, so banks have to contract the credit they have awarded, and so everything will look even darker yet.

Regulators fill their mouths with sophisticated remarks about the need of countercyclical regulations but manage somehow, with a little help from silent FT, to avoid being held accountable when they design pro-cyclical nonsense.

@PerKurowski ©