In crossroads where some cars are allowed to speed through at 62.5, and other at 12.5, which would cause the greatest accidents?

Robert A Denemark writes: “the financial system provides incentives to engage in risky behaviour that tends toward crisis… It is a good idea to avoid accidents even when there are no traffic laws, but if vehicles collide there can be no official blame. Legitimacy, the focus of the editorial, comes from the recognition of most people that the rules make sense. Do they?” “Financial system itself makes crises likely” August 18.

Do current rules make sense? Let me answer that question this way: In that crossroad where bankers take decisions about credit, regulators allowed bank equity to be leveraged much more with the net margins if these came from “safe” borrowers than when produced by “risky” ones. For instance Basel II, allowed a 62.5 times leverage for the AAA rated and only 12.5 times for SMEs.

Sir, where would you think the biggest and most dangerous crashes could occur?

The 20% risk weighted AAA rated securities, and 0% to 20% risk weighted sovereigns, like Greece, is a good hint for you to come up with the right answer.

Sir, Bank regulators should learn about risk compensation and shared space philosophy.

@PerKurowski

Bernanke, what bank risks? Motorcycles are riskier than cars but yet more die in cars than in motorcycle accidents.

Sir, I refer to Martin Wolf’s FT lunch with Ben Bernanke “Hostility and hyperinflation” October 24. Bernanke states that “the Federal Reserve was originally set up primarily to address financial panics, not do monetary policy”.

And so Martin Wolf asks: The late Hyman Minsky, I point out, argued that “stability destabilises”. So did the very notion of a “great moderation” cause the imprudent behaviour?

And to which Bernanke replies: “individually rational behaviour can be collectively irrational. And that’s why the regulators have to do what they can to constrain individual behaviour, so that it doesn’t lead to collectively irrational outcomes.”

At which point, had I been invited to the lunch, I would have observed and asked the following:

Banks respond to the credit risk in a risk-adverse way. More risk higher interest rates and lower exposures – lower risk lower interest rates and larger exposures.

Bank regulators also use their credit risk weighted capital requirements for banks in a risk adverse way, namely more risk more capital less risk less capital.

So Mr. Bernanke, and you too Mr. Wolf, is it not so that by reacting to credit risk in the same way banks do the regulators, instead of constraining individual behavior, potentiate individual behaviour? What they would have answered to that is anyone’s guess.

And when Bernanke states: “the amount of [bank] capital you should hold depends on the kind of assets and the kind of businesses you have. And if it’s a fixed leverage ratio, then you’re going to have every incentive to load up on risk.” I would again have impolitely interrupted to ask: Mr. to load up on what risks? Driving motorcycles is by far more risky than going by cars… but those who go by car and suffer mortal accidents still surpass by far those who die riding motorcycles.

Mr. Bernanke, if you happen to read this, may I invite you to a debate, perhaps moderated by Mr. Wolf? In that debate you would defend the current portfolio invariant only-on-expected-credit-risk weighted capital requirements for banks; and I would defend an 8 to 10 percent capital requirements against all assets, to cover for unexpected losses, solely based on the risk of regulators not knowing what they are doing.

@PerKurowski ©