Credit risk-weighted capital requirements make it impossible for banks to price risk

Sir, I refer to Howard Davies’ in FT’s A-List, “Dilemma of defining risk” September 10.

There Davies states: “Regulators accept that banking necessarily entails risk. Their view, however, is that banks should know what risk they are taking on, why they are doing so, and should ensure that risk is priced properly”.

Indeed, it should be so, but it is not! 

Regulators, by using credit risk weighted capital requirements for the banks, not only send the message that they do not believe banks know what risk they are taking on, and worse, much worse, they make it completely impossible for banks to price risk properly. As is, banks price risks adjusted for the capital required, and that distorts all.

Regulators have yet not understood that the risk they must be concerned with has nothing to do with the credit risk of a bank’s exposure and all to do with how a bank manages those credit risks. Today they act like a nannie helping a child to cross a street looking only at the traffic light and not looking at the kid.

What should regulators do? Fix some capital requirements in order to cushion for any unexpected losses. But for the unexpected, you cannot, as regulators, by their own admission have done and do, use the expected.

To me it is surrealistic to read Douglas Flint expressing how the main preoccupation of bankers is “to protect themselves and the firm from future censor” by regulators when it is the regulators who should hang (illustrative… I think) for their mistakes. 

As is Basel II and III risk weighted capital requirements for banks is a true regulatory nightmare.