What bank regulators do not yet understand and do not yet discuss, is truly scary stuff

Sir, John Vickers who chaired the Independent Commission on Banking (ICB) writes: “A central lesson of the crisis of 2008 was that banks had woefully inadequate equity capital” “The Bank of England must think again on systemic risk” February 15.

That is dangerously imprecise! The central lesson of the crisis was that banks had woefully little capital against assets that had ex ante been perceived or deemed very safe as a result of woefully wrong regulations.

The regulators allowed banks to hold much less equity against safe assets; which allowed banks to leverage much more their equity with safe assets; and which allowed banks to earn higher risk adjusted returns on equity on safe assets than on risky assets.

And the fact that regulators are still not able to comprehend that it is not their role to regulate based on what assets a bank has, but based on how banks manage those assets, is just scary.

And the fact that regulators are still not able to digest the truth that the assets that are really dangerous to the stability of the banking system are not the risky but those perceived as safe, is just scary.

And the fact that the distortions in the allocation of bank credit to the real economy that risk weighted capital requirements produces are not yet even discussed, is just scary.

@PerKurowski ©