Perceived credit risk is all about expected losses, while bank capital should be a buffer against unexpected losses.

Sir, John Kay writes that Warren Buffet, “In a revealing moment, when asked about the absence of conventional due diligence in his acquisition process; acknowledged that Berkshire had made bad acquisitions, but never one that could have been avoided by the kind of information that due diligence might have revealed.” “The Buffett model is widely worshipped but little copied” May 4.

Translate the above into bank regulations and it would mean: Banks could always lose but not because of the information a credit analysis might have revealed… much more dangerous than the expected, is the unexpected.

And that Sir is one of the many reasons why I believe current regulators are worse than fools. They defined the capital banks should be required to have, in order to confront unexpected losses, based on expected perceived credit risks. 

Please don’t tell me you think that is smart. In fact, the safer something is perceived, the greater is its potential to deliver huge unexpected losses. In fact, from this perspective, the safer something is perceived, the larger should the capital requirements for a bank be.

By the way let me make it clear that I am arguing this only to make a point, and I am not now suggesting we should distort the allocation of bank credit to the real economy in the other direction, favoring the risky.

Sir, if we are to distort, let us at least, as a minimum minimorum, do so with a purpose. For instance make the capital requirements for banks based on job creation and earth sustainability ratings.

PS. Here are plenty of reasons for why I believe the bank regulators in the Basel Committee are complete idiots… or something worse 

@PerKurowski ©