February 02, 2012

A market distortion error is much worse than a model error

Sir, as you might guess from my hundreds of letters to you over the last 5 years and which were ignored, I completely agree with Pro Johan Lybeck that we should “Forget Basel III and head straight for Basel IV” February 2. I have though two differences with him. 

When he suggests “fixed risk-weight for all assets, so as to eliminate “model error”, I much prefer the same risk-weight for all assets, so as to eliminate the much worse non-transparent market distortion error. 

The second difference is that he suggests that the changes in capital requirements should be implemented now, even though that could mean banks could be partially owned by the state because they cannot raise new capital in time. My suggestion is to allow banks to keep the original capital requirements on any assets booked previously, since there is no need to cry over spilled milk, and allow the banks to use whatever new capital they can raise for the new business we so sorely need.