August 17, 2015

Nonsense! Why should ECB worry about banks' risk models being right, when its problem is when these are wrong?

All those studies are utter nonsense. Let us suppose banks’ risk models work well. Would ECB have any problem with that? No! Its only problem is when those risk models do not function. And, so if you are going to ask banks to hold capital, it is precisely against that or any other unexpected risk… and frankly, who can evaluate those risks?

Noonan writes: “various studies have found widespread differences in banks’ Risk Weighted Assets models… The 123 banks together have more than 7,000 internal models”. Though all those models are most certainly used to justify lower capital needs of banks, I still find that slightly comforting… since, this way, there are less risk these could all be wrong in the same way.

Because when I read: “Harmonising supervisor’s approaches — including to risk models — was a priority, said the ECB.”, that scares me even more, because the possibility of introducing a fatal not diversifiable systemic risk is much increased. 

In 2003, as an Executive Director of the World Bank, with respect to Basel Committee regulations I warned: "A mixture of thousand solutions, many of them inadequate, may lead to a flexible world that can bend with the storms. A world obsessed with Best Practices may calcify its structure and break with any small wind.”

The absolute least we must require of ECB is that all the consultants who would be working at this, and who at the end of the day are paid by taxpayers, put up their conclusions on the web, so that we can really shame them if they get it wrong. (Or shoot them if they get it wrong… since as a consequence much people will most likely suffer… and even die).

In my mind, and pardon the vulgarity, with these studies ECB is just trying to cover its behind… at taxpayers’ expense.

I dare ECB to allow me, on a pro-bono basis, to formally record my complete criticism of the pillar of current bank regulations, namely the risk-weighted capital requirements for banks.

ECB, IMF, Basel Committee, FSB, Fed, FDIC, Systemic Risk Council, anyone involved, for the umpteenth time I warn you: One thing is a simple fixed capital requirement on all bank assets, which allows the markets to figure out and manage the risks as best as it can. Something entirely different is many, few, or even one single model that sets the risk-weights that determine the capital requirements of banks. That can only confound the markets making it impossible for anyone to better estimate the real risks… making it more possible for the last safe haven to become overpopulated, and us dying suffocated there for lack of oxygen.

Please regulators… you are playing around with extremely dangerous explosive material.

In 1999 in an Op-ED I wrote: “The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause its collapse”

In 2008 we already saw one AAA-rated bomb explode… and we sure do not need more of those. 

PS. Come to think about it. This ECB research project sound about the most useless navel gazing project I have ever heard of. A risk model, if it is worth anything, must be very dynamic, meaning the one you researched like an hour ago, could perhaps have very little to do with the one being used in this minute. Or, will the banks now require ECB’s or Basel Committee's permission to change the model they use?

PS. On the other hand ECB’s research project formally indicts the Basel Committee and FSB as being clueless about what they are doing.

Just one more thing!

So ECB, during 4 years you intend to contract many expensive consultants to check 7,000 different models that determine the risks weighted assets of banks, in order to determine the risk for banks.

So ECB: How many consultants will be checking the risks all these risk-weighted asset models imply in terms of possible bad allocation of bank credit to the economy?