June 11, 2017

In terms of creating systemic risks for our banking system, current regulators are the undisputable champions

Sir, former banker and banking lawyer Martin Lowy writes: “Dodd-Frank and Basel III capital rules have made banks and their holding companies stronger.” “How the next financial crisis won’t happen”, June 10

Well I sure know that the next financial crisis will absolutely not be the result of excessive bank exposures to something perceived as risky, as to what is rated below BB-, that to which regulators assigned a risk weight of 150%. Much more likely it will be from excessive exposures to something rated as safe as AAA, that to which regulators only assigned a meager 20% risk weight.

Really big bank crises, except from really extraordinary unexpected events, are the result of the introduction of something that can grow into a systemic risk.

What systemic risk do I see?

I see credit ratings, like when in 2003 in a letter published by FT I wrote: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds. Friends, please consider that the world is tough enough as it is”

I see risk weighted capital requirements, like those that allow banks to leverage more with what is “safe” than with what is “risky”., and therefore distorts, for no good reason, the allocation of bank credit to the real economy.

I see standardized risk weights that impose a single set of weights on too many.

I see regulators wanting to assure that banks all apply similar approved risk models, thereby again ignoring the benefits of diversification.

I see stress tests by which regulators make banks test against the some few same stresses, as if real stresses could be so easily identified.

I see living wills, as perfectly capable to create systemic risks that at this moment are hard to see.

In all, in terms of creating dangerous systemic risks, hubris filled bank regulators aee the undisputable champions.

The main cause for that is that our bank regulators find it more glamorous to concern themselves with trying to be better bankers, than with being better regulators.

Regulators, let the banks be banks, perceive the risks and manage the risks. The faster a bank fails if its bankers cannot be good bankers, the better for all.

Your responsibility is solely related to what to do when banks fail to be good banks.

And always remember these two rules of thumb:

1. The safer something is perceived to be, the more dangerous to the system it gets; and the riskier it is perceived, the less dangerous for the system it becomes.

2. All good risk management must begin by clearly identifying what risk can we not afford not to take. In banking the risk banks take when allocating credit to the real economy is precisely that kind of risks we cannot afford them not to take.

As in 1997 I wrote in my very first Op-Ed. “If we insist in maintaining a firm defeatist attitude which definitely does not represent a vision of growth for the future, we will most likely end up with the most reserved and solid banking sector in the world, adequately dressed in very conservative business suits, but presiding over the funeral of the economy. I would much prefer their putting on some blue jeans and trying to get the economy moving.”