Basel Committee’s risk weighted bank capital requirements is fodder for our wishful thinking hopes.

I refer to Tim Harford’s “From forgeries to Covid-denial" On how we fool ourselves: Whether believing implausible statistics or falling for frauds, humans are addicted to wishful thinking” FT, January 30, 2021.

Sir, I ask, the Basel Committee’s risk weighted bank capital requirements, could that just be a forgery made to satisfy our deep wishes of our banks always being safe?

Now why so little objections? Edward Dolnick explained it with: “Experts have little choice but to put enormous faith in their own opinions. Inevitably, that opens the way to error, sometimes to spectacular error.”

By the way. Where has Academia been on all the regulatory distortion of the allocation of bank credit?

Could it be that we so much wish some forecasts to be right, that we are unable to see when they fail?

Sir, Miles Johnson ends his discussion of failing economic forecasts with: “It is not surprising that forecasters continue to get things wrong. What remains remarkable is that those who question the assumptions that underpin their repeatedly failing models are still treated as radicals” “Forecasters’ failings highlight the flaws in our assumptions” April 26.

Regulators, they say, based on some careful research, forecasted that what is perceived as risky is much more dangerous to our bank system than what is perceived as safe. And so they gave us risk weighted capital requirements with instance with Basel II’s risk weight of 20% to what is AAA rated and 150% to what is rated below BB-.

The 2007/08 crisis, caused exclusively by assets that because they were perceived, decreed or concocted as safe, residential mortgages, sovereigns like Greece or AAA rated securities, the banks were allowed to leverage much more with, proved without any doubt how wrong that forecast was. 

And there are many more faults with this regulations that completely distorts the allocation of credit to the real economy.

Yet the assumption that underpin that regulation is not questioned, and if someone does, like I have done persistently for about two decades, I get treated like a radical, or at least as someone obsessed that should not be given much voice. 

For instance FT’s Martin Wolf, even though in 2012 he writes: “Per Kurowski reminds me regularly, crises occur when what was thought to be low risk turns out to be very high risk”, in the same breath he holds that “it is essential to recognise that so called ‘risk-weighted’ assets can and will be gamed by both banks and regulators”. That of course means Wolf does not see this regulations as something build upon a fundamentally mistaken principle, but mostly just suffering a kind of technical glitch in its execution.

Why is this so? Perhaps it is because we all want so much our banks to be safe, so when regulators tell us the bank capital requirements are risk-weighted, we so much want that to be true that we don’t even dare contemplate the possibility that, the experts, could be 180 degrees off the mark.

http://perkurowski.blogspot.com/2016/04/here-are-17-reasons-for-why-i-believe.html

@PerKurowski

Risk weighted capital requirements for banks, the mother of all wishful thinking, of all desirability bias?

I refer to Tim Harford’s discussion about desirability bias and wishful thinking. “Be careful what you wish for in politics” June 17

Basel Committee: “We know all of you want banks to be safe. For this purpose we have decided to impose risk weighted capital requirements on the banks”.

The world: “Risk-weighted? Hmm, sounds reasonable, that should do it. Good job guys!”

But that supposes, first that risks can be perceived adequately and second that the responses to these perceptions will be adequate. What are the chances of that? Nil!

That is why I nominate this the pillar of current bank regulations, to win the contest for the greatest wishful thinking during at least the last three decades.

So big was it that very few expressed some concerns about that it could dangerously distort the allocation of credit to the real economy.

So big was it that when with Basel I, 1988, it decreed a risk weight of 0% for the sovereign and 100% for the citizens, no one shouted, “You’re just a bloody bunch of statists/communists!”

So big was it that when 2004, with Basel II, no one found something wrong with a risk weight of 20% for AAA rated assets, that which bankers could love too much, and one of 150% for what is rated below BB-, that which bankers would not touch with a ten feet pole.

So big was it that when the 2007/08 crises broke out solely because of excessive bank exposures to assets that required banks to hold almost no capital, like AAA rated securities and sovereigns like Greece, the world screamed about the effects of “deregulation” and said not a word about “miss-regulation”.

So big was it that the Frank-Dodd Act, in its 848 pages, did not even mention the Basel Committee. And when that Act mentions risk weighing, no real concern is raised, but other risks that should also be included are pointed out.

So big was it that all type of efforts are being put in trying to make the credit ratings better, ignoring the clear danger present when there is even more trust put into these ratings.

So big was it that all those who had anything to do with it, like Mario Draghi, were promoted.

So big is it that basically every day we hear statements on banks being adequately capitalized, comparing current risk weighted oranges with former apple capital ratios that had no such thing.

@PerKurowski

“Wishful thinking” should not be used to make unforgivable dumb thinking more socially acceptable.

Sir, Tim Harford discusses several experiments on how wishful thinking can influence the outcome. In most of these the sufferer of wishful thinking consequences is the wishful thinking himself. But, when Harford mentions: “Perhaps a belligerent politician or union leader would find his or her position strengthened by a strike. A general might desire a war. Lawyers might profit from urging their clients to go to court.” he is clearly referring to bad wishful thinking, “When wishful thinking becomes wasteful”, November 7.

So let me ask? How wishful was it not of regulators to think that by interfering with some capital requirements based on credit risk they could stop banks from failing without distorting the allocation of bank credit to the real economy? Or, if it was not wishful thinking, was it pure dumb unforgivably irresponsible thinking?

How wishful was it not of regulators to think that they did not need to look back at history to see what caused bank crises because it sufficed to look at the ex ante perceived credit risk of the assets? Or, if it was not wishful thinking, was it pure dumb unforgivably irresponsible thinking?

How wishful was it not for regulators to think they could empower some very few human fallible credit rating agencies, to decide how much capital banks needed to hold, and that these were not going to be captured? Or, if it was not wishful thinking, was it pure dumb unforgivably irresponsible thinking?

Whenever the concept of wishful thinking might be used to sort of make unpardonable dumb thinking more socially acceptable, I have a problem with it.  

@PerKurowski ©