October 18, 2013

Before sending watchdogs into the shadows, should we not get better ones for banks in the light?

Sir I refer to Sam Fleming and Patrick Jenkins reporting Paul Tucker saying “it would be ‘absolutely disastrous’ if the economic fragility of banks was recreated outside the mainstream banking sector”, “Watchdogs urged to look in the shadows”, October 18.

I do not agree. What we should really be scared of are for our truly bad watchdogs now also going for the shadows, after having messed up so much the banks in the light. Just as an example, in the shadows, no one would even dream of leveraging 30 to 50 times, like supervised banks were allowed to do, and did.

Sir, let me ask you one question, please!

If you were a regulator, what would you think poses the greatest dangers for us with the banks, the possibility of their excessive exposure to something rated AAA to AA and which then, ex post, turns out to be risky, or their “excessive” exposure to something rated below BB- ad which would, ex post, turns out to be even more risky than that?

I dare venture you would answer the first, since you would know there would be very few or no "excessive exposures" at all to anything rated BB-. And, if so, the banks would have collected a lot of risk premiums too... which is also capital (equity).

But the risk-weights of our current watchdogs are 20% for the first and 150% for the latter, meaning banks need, according to Basel II, only to hold 1.6% in capital against the first but 12% against the latter, which means banks are allowed to leverage 62.5 to 1 with AAA to AAs but only 8 to 1 with something rated below BB-. Explain that!

You see, the Basel Committee's risk weights measure the risks for the banks of their assets and borrowers, but not the bank risks for us. You see, our and bank regulators’ problems with banks, have absolutely nothing to do with banks and bankers getting it right, and absolutely all to do with banks and bankers getting it wrong!

Before sending watchdogs into the shadows, should we not get better ones for banks in the light?