November 22, 2017

True bank regulations should also not be like gambling.

Sir, I refer to Izabella Kaminska’s “True investing is not the same as gambling” November 22.

But Sir, what did bank regulators do with their risk-weighted capital requirements for banks if not gambling? They gambled on that bankers and credit rating agencies would perceive and manage risks correctly…and this even when bank crisis, when not the result of unexpected events, have always resulted from banks having ex ante perceived something as safe, but which ex post turned out to be risky.

Here again are the four possible outcomes of any bank lending:

1. Ex ante perceived safe – ex post turns out safe – “Just what we thought!”

2. Ex ante perceived risky – ex post turns out safe – “What a pleasant surprise! Another entrepreneur who makes it because we are so good bankers.”

3. Ex ante perceived risky – ex post turns out risky: How lucky we only lend little and at high rates to it.

4. Ex ante perceived safe – Ex post turns out risky: “Holy Moly now what do we do? Call the Fed for a new QE?”

The role of a bank regulator would of course be to work solely on the possibilities that banks did not perceive risks correctly or, if they did, did not manage these perceptions correctly.

And in that respect, the safer something is perceived the more dangerous it can become, and the riskier something is perceived the safer it becomes. Just the same reason for why so many more die in car accidents than in motorcycle accidents. 

The saddest part though is that even if bankers or credit rating agencies perceived risks correctly, the final results of all this would be bad. That because any risk, even if perfectly perceived causes the wrong actions, if excessively considered.

Bankers consider perceived credit risk when determining the size of their exposures and the risk premiums they should collect… but there, after 600 years of banking, suddenly the regulators invented that exactly the same perceived risks needed also to be considered in their capital too. And, since then, what is perceived as safe is getting way too easy credit while, what is perceived as risky, like SMEs and entrepreneurs are not getting the credits the real economy need them to get.

Sir, come one, don’t be so scared, live up to your motto of “Without fear and without favor”. Dare request from any regulator, for instance from FSB’s Mark Carney, an explanation for Basel II’s risk weights: that of a meager 20% for the so dangerous AAA rated, and a whopping 150% for the so innocous below BB-