May 21, 2018

There’s never a wrong time to begin correcting bad bank regulations, such as the current ones.

Sir, Rana Foroohar writes: “Financial crises always start the same way” and refers to “Over-confident financiers [and] lax regulators”, “The wrong time to weaken bank reform” May 21.

The 2007/08 crises resulted from overconfident regulators, those who believed so much in the capacity of credit rating agencies that, if private sector assets were rated AAA to AA, banks were allowed to hold these against only 1.6% in capital, meaning they were allowed to leverage a mindboggling 62.5 times. The financiers on their hand, much more than overconfident, were lax and did not have it in them to resist the temptations of such regulatory generosity.

Sir, just think about how much sufferings and how many unrealized dreams could have been avoided had only the following four simple questions been asked of the Basel Committee’s about their risk weighted capital requirements for banks. 

1. What? Do you really know what the real risks for banks are? If you do, why are you not bankers?

2. What? Don’t you see that allowing banks to leverage differently with different assets will lead to a new not-market-set of risk adjusted returns on equity. Are you not at all concerned this could dangerously distort the allocation of credit to the real economy?

3. What? Do you think that what’s perceived risky, that which bankers adjust to by means of lower exposures and higher risk premiums, is more dangerous to the bank system than what they perceive as safe?

4. What? A 0% risk-weight of sovereigns? That could only be explained by their capacity to print currency in order to get out of debt. But is that not also one of their worst possible misbehaviors?

The saddest part though is that 30 years after that faulty regulation was first introduced with the Basel Accord in 1988, these questions are still waiting for an answer.

Sir, there is never the wrong time to start correcting for such bad regulations. You could argue that the introduction of a leverage ratio is doing that. Indeed, but as long as the risk weighted capital requirements remain these will be influencing credit decisions where it most counts, on the margin.

And it is only getting worse. Foroohar writes “larger banks with assets ranging from $250bn to more than $2tn… will now be able to reclassify municipal bonds as “high quality assets”, making it easier for them to game the liquidity coverage ratio.” What does that signify? Those municipalities will get too much credit in too easy terms… just like Greece.