October 09, 2013

Banks and regulators managing the same ex ante perceived risks, simultaneously, can only result in chaos and tears

Sir, Ian Cormack writes of “Banks´ deadly blend of complexity and leverage” October 9. And he holds that though many large businesses are very complex “the differentiator for banking is risk… demanding rigorous risk managing and risk reporting”. That is true but that does not even remotely describe the real difficulties, or impossibility, of managing bank risks today.

Banks look at the ex ante perceived risk of assets and adjust to these (in the numerator) by means of interest rates, size of exposures and other ways like hedging or contractual terms. But then come the bank regulators and adjust for basically the same ex ante perceived risk (in the denominator) by means of their risk weighted capital requirements.

That creates all sort of feed-back noises and, of course… the whole system overdoses on ex ante perceived risks, and all result in chaos.

God, make these regulators understand what they are doing!