April 02, 2016

Rules that make all banks behave the same can pose greater systemic risks than all SIFIs put together.

Sir, I refer to Brooke Masters article on “systemically important financial institution whose failure could destabilise the economy” “MetLife’s court win means US regulators should redraft rules” Saturday 2.

Before regulating or redrafting anything, regulators should at least come to understand that their own rules might be the source of the most dangerous systemic risks.

In 2001, in an OpEd I wrote the following onbank regulations:

“The regulatory risk: Before there were many countries and many ways of how to regulate banks. Today, with Basel proudly issuing rules that should apply worldwide, the effects of any mistake could be truly explosive. 

Excessive similarity: Encouraging banks to adopt common rules and standards, is to ignore the differences between economies, so some countries end up with inadequate banking systems not tailored to their needs. Certainly, regulations whose main objective appears to be only to preserve bank capital, conflict directly with other banking functions, such as promoting economic growth, and democratize access to capital. 

Low diversity of criteria: A smaller number of participants, less diversity of opinion and, with it, increased risk of misconceptions prevailing. Whoever doubts that, should read the dimensional analysis that ratings agencies publish. 

Backlash: The development of decision-making processes has benefits but also risks. Thus we see that the speed of information itself, which promotes quick and immediate response, can exacerbate problems. Before, those who took the problem home to study it, and those who simply found out late, provided the market a damper, which often might have saved it from hurried and ill-conceived reactions.”

And already in 1999 in another OpEd I had written: “The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause its collapse”

And then Basel II’s 20 percent risk weight for AAA rated securities, caused the financial crisis 2007-08; while Basel I’s zero riskweight assigned to sovereigns, doomed sovereigns like Greece.

Of course there is a need to think about the systemic risk of SIFIs, but even more important, is looking to minimize the systemic risks of bank regulations… or at least to recognize their existence.

A million of individual small banks can easily be turned into a very dangerous Systemic Overall Important Banking System, by just some rules drafted by some members of that mutual admiration club known as the Basel Committee for Banking Supervision.

@PerKurowski ©