February 04, 2017

Risk weights of 20% for AAA rated and 150% for the below BB-, evidences the Basel Committee’s intellectual failure

Sir, Brooke Masters makes a lot of good points in her “Loss of a safety-first regulatory regime is no reason to party” February 4. Unfortunately, again, as is usual for almost all commenting on bank regulations, these are solely from the perspective of the safety of banks; so rarely from the perspective of the borrowers, most specially the “risky” borrowers, like the SMEs and entrepreneurs, and whose borrowings are taxed with the highest capital requirements for the banks.

When Masters’ writes that relative to some large institutions “Some smaller banks are struggling with high compliance requirements”, it is so in much because the natural borrowing clientele of smaller local banks belong to the “risky” group.

Masters ends by recommending: “just trim back the Dodd-Frank rules and stay in the Basel process but temper its safety drive… even try leaving the fiduciary rule in place”

I do not agree. The Basel Committee has produced regulations that make no sense to the real economy and, if you really want banks to have a chance to be sustainably safe, you must make sure the allocation of credit to the real economy is efficient and adequate. The Basel Committee with its risk weighted capital requirements dangerously distorts that allocation. And all based on the completely erroneous theory that what is ex ante perceived as risky is riskier ex post to the banks than what is perceived as safe.

That the AAA rated, so dangerous in that a perceived safety can easily cause very high exposures, have a risk weight of 20%, while the really so innocuous below BB-rated are assigned a risk weight of 150%, is about the best example of how confused current bank regulators are. To rebuild those regulations using the same builders and who are not even recognizing the mistakes cannot lead to anything good. Face it, banking after around 600 years of functioning, was in 1988, with Basel I, dramatically changed for the worse. 

The Dodd-Frank Act? What can I say: to me it is a monument to legislative surrealism. For instance in its 848 pages it does not even mention the Basel Committee for Banking Supervision.

Fiduciary role? Since no one can really guarantee that any fiduciary responsibility is complied with, it is better not to imply such thing with regulations. The best approach is just explaining to investors what its acceptance or not by the advisors, is “supposed” to mean. 

PS. It would be great if Brooke Masters used her influence to get some answers from any bank regulators to these questions.

PS. The sad truth is that our banks are in the hands of Chauncey Gardiner type regulators.