May 03, 2014

Ever more complex finance requires denser and duller, bordering on brain-less, hard-headed stubborn bank regulators.

Sir, Tracy Alloway writes “If the institutions which create these [sophisticated financial] products cannot correctly asses their value, then what hope is there for us?”, “Ever more complex finance parts way with economic reality” May 3.

Indeed but it is worse than that… because what hope can we have that our bank regulators understand those products? In 2003, when Basel II was being discussed I told some hundred regulators during a workshop the following: “Let me start by sincerely congratulating everyone for the quality of this seminar. It has been a very formative and stimulating exercise, and we can already begin to see how Basel II is forcing bank regulators to make a real professional quantum leap. As I see it, you will have a lot of homework in the next years, brushing up on your calculus—almost a career change.”

The truth is that regulators did not know what they were doing with simple Basel II and they know of course much less with Basel III, which is about a hundred times more complex and technical.

And this should lead us to the truth of regulations… the more complex the issue is the more dumb must the regulators act, like refusing trying to understand it all, and stubbornly holding to some simple rules of thumb… like 8 percent of shareholder’s equity against any asset.

The role of the regulators is not to control the banks for the perceived ex ante risks, the expected losses, that is the job of the bankers and, if they can’t do that they should not be bankers. The role of the regulator is to safeguard against eventual ex post risks, unexpected losses, and since the unexpected cannot be calculated, they can for instance allow themselves not having any knowledge of calculus.

God save us from the hubris driven intelligent besserwisser spread-sheet equipped regulators trying to outsmart bankers.