October 06, 2016

Risks, even if perfectly perceived, can lead to very wrong actions if excessively considered

Sir you write: “as the expansion of world trade has slowed over the past few years, familiar warnings about the political risks to growth have re-emerged… The International Monetary Fund warned this week that political risk was one of the biggest threats to the world economy… But unless and until these political risks materialise, there is no need to panic about trade, and the best way of keeping it expanding is simply to encourage overall economic growth” “The IMF sends a signal on political risk realities” October 6.

That is entirely correct Sir. Risks, even if perfectly perceived, can lead to very wrong actions, if excessively considered. But Sir, why do you refuse to apply that kind of argument to current bank regulations?

There we had the banks perceiving credit risk, some doing it well an others less so, and then deciding on what amount of exposure they wanted, and what interest rate, risk premium, they would charge. But NO! that was deemed insufficient by the meddling and nervously nannying technocrats in the Basel Committee, and so they invented that they should also react to the same risk perception, and set the capital a bank should have against an asset accordingly. And so credit risk (or credit safety too) got to be excessively considered, which has completely distorted the allocation of bank credit to the real economy.

But not a word is spoken about this; probably because it is all backed by some very hard to understand risk management concepts that few dare to discuss. And so now we have for instance ended up with the absurdity of having what can really grow into dangerous excessive bank exposures, like the AAA to AA rated, being risk-weighted at 20%, while the totally innocuous below BB-rated get a 150% risk weight. Sheer lunacy!

So now, ironically, in order for bank credit to be efficiently allocated to the real economy; and not endanger the banking system’s stability, the perceived risks need to be wrong. What is “safe” must be perceived riskier and what is “risky” must be perceived safer. 

@PerKurowski ©