September 14, 2015

#1 Macro-prudential rule is never take for granted those in charge, like bank regulators, know what they are doing

Sir, Richard Milne quotes Stefan Ingves with “sailing a small boat on the ocean: it’s good if you know how to sail.”, “Riksbank head warns on tools to tackle crises”, September 14.

But let us not forget that Stefan Ingves is the current chairman of the Basel Committee, and as such, we could presume he agrees entirely with the current risk-weighted capital requirements for banks. In essence that regulation implies the following:

The better things are going for some assets, and so the safer these look (like house mortgages), the less capital are banks required to hold against these, and so the more incentives do banks have to lend, and thereby make these assets look even better yet… that is until the overcrowding of those safe havens become so dangerous that the whole banking system fails.

The worse things are going for some assets, and so the riskier they look (like loans to SMEs), the more capital must banks hold against these, and so the more incentives will banks have to reduce lending, and thereby make these assets look even worse yet… that is until riskier but perhaps more productive bays are left so unexplored that the whole economy fails.

Sir, the first and most important macro-prudential rule is that of never taking for granted that those in charge of sailing the boats know how to sail. And as I have argued for years, current bank regulators, which include Mr. Ingves, have no idea about what happens out there on the real oceans… their experience might be restricted to having played with toy boats in bathtubs.

The second most important macro-prudential rule with respect to banks, and boats, is that instead of by all means trying to stop these from going under, assist these to fail expeditiously, whenever they seems to be insufficiently seaworthy.

If it were up to me, and knowing these are to cover against unexpected losses I would set the capital requirements for banks based of cyber attack or being struck by asteroids, so as not have to spell out these as based on risks of bankers not knowing how to manage perceived risks, and worse, on risks of regulators trying to manage risks.

PS. “Gud gör oss djärva” “God make us daring” is a Swedish psalm. It would do us much good if bank regulators tried to understand its message....perhaps Riskbank would be a more appropriate name than Riksbank for a nation that has prospered thanks to risk-taking and much reasoned audacity.

PS. Axel Oxenstierna: “An nescis, mi fili, quantilla prudentia mundus regatur?”, “Do you not know, my son, with how little wisdom the world is governed?”, “¿No sabes, hijo mio, con que poca sabiduría el mundo esta gobernado?”, “Vet du inte, min son, med hur litet förstånd världen styrs?”