March 03, 2018

In terms of estrogen and testosterone, are there differences between bank exposures to what is perceived risky, and risky excessive exposures to what is perceived as safe?

A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain” Mark Twain

Sir, Cordelia Fine writes: “Risk management in financial institutions is too important to be guided by scientific ideas well beyond their sell-by date. Blaming financial misadventures on a testosterone-fuelled male drive distracts us from what’s more likely to make a difference: regulation and culture. The best in-house antidote for bankers selling junk products and regulators bending to conflicts of interest isn’t women; it’s a dismissal slip”, “The Testosterone Rex delusion” March 3.

Absolutely! But with reference to the risks taken on by the banks that caused the 2007/08 crisis, that dismissal slip should foremost be given to regulators for having the ex ante perceived risks of banks assets substitute for the ex post dangers to our banking system.

And with reference to the absurd low response of the economy to the extremely high stimulates provided, the regulators should also be given that dismissal slip, for ignoring the purpose of banks, something that includes the efficient allocation of credit to the real economy.

Fine references Swedish journalist Katrine Marçal with whether “an investment bank named Lehman Sisters could handle its over-exposure to an overheated American housing market.” That is an ex post description that has little to do with the ex ante perception of the risks, and clearly less to do with bankers wanting to lend when it rained.

If some testosterone is needed to understand that risk-taking is the oxygen of development, and so the need for banks to also lend to those perceived as risky, like to entrepreneurs, then the regulators showed a fatal lack of it.

Their risk weighted capital requirements, more ex ante perceived risk more capital – less risk less capital is as dangerously nonsensical as can be. These only guarantee that when the true risks for our banking system happens, namely the dangerous overpopulation of safe havens, banks will stand there with especially little capital.

By allowing banks to leverage much more with assets perceived, decreed or concocted as safe, like AAA rated securities, like residential mortgages, like sovereigns (Greece) they allowed banks to earn the highest expected risk adjusted returns on equity on what was perceived as safe. Mark Twain could have said that made bankers wet dreams come true; and that was, while playing, the music to which Citigroup’s Chuck Prince held bankers had to dance.

And so, since what the members of the Basel Committee and the Financial Stability Board and most of their colleagues have really proven, is to be suffering from an excessive risk aversion, what would then Cordelia Fine opine, in terms of testosterone and estrogens?

Here is an aide memoire on the major mistakes with the risk weighted capital requirements