January 04, 2016

Bank regulators have set their highest bank capital requirements for what poses the least dangerous tail risks

Sir, I refer to your “World economy of so-so growth and fat tailed risk” January 4, and your reporters “Unlikely suspects are in the wings for 2016” of January 2.

The latter states: “Some risks are quotidian. Will a company struggle to generate cash flow, or will a particular asset fall out of vogue. Then there are outcomes that exist in the narrow, far reaches of statistical probability distributions, known as “tail-risks”. A hefty blow to investments is usually the result when such shocks occur.”

And with respect to current bank capital requirements, those that are supposed help cover for unexpected losses I have two questions for your reporters.

First, what can cause more unexpected losses, quotidian risks like credit risks, or the kind of events that they exemplify as some possible dangerous tail risks?

Second, in the case of credit risks, what has the capacity to produce the most sizable unexpected losses, what is perceived as safe or what is perceived as risky?

The correct answer to those questions should indicate the absurdity of setting the highest capital requirements for that that in terms of a quotidian credit risk is perceived as risky.

Think of it. The risk weight for a private sector asset rated below BB- was set at 150 percent, while that of an AAA to AA rated was only 20 percent. Is below BB- rated, something which scares away any risk adverse banker, really more dangerous to the banks than what is AAA rated? 

Sir, how long will your reporters ignore this sad truth? Is there a tail risk they personally have to be afraid of?

Laura Noonan in “EU board budgets for 10 bank failures” December 4, writes that the Single Resolution Board is seeking €40m in accounting advice, economic and financial valuation services and legal advice, to be used in the resolution of struggling Eurozone banks from 2016 to 2020.

Sir, have any of the possible big shot candidates for that consultancy ever informed bank regulators that their capital requirements make no sense? Sorry, just asking.

@PerKurowski ©