June 17, 2017

Risk weighted capital requirements for banks, the mother of all wishful thinking, of all desirability bias?

I refer to Tim Harford’s discussion about desirability bias and wishful thinking. “Be careful what you wish for in politics” June 17

Basel Committee: “We know all of you want banks to be safe. For this purpose we have decided to impose risk weighted capital requirements on the banks”.

The world: “Risk-weighted? Hmm, sounds reasonable, that should do it. Good job guys!”

But that supposes, first that risks can be perceived adequately and second that the responses to these perceptions will be adequate. What are the chances of that? Nil!

That is why I nominate this the pillar of current bank regulations, to win the contest for the greatest wishful thinking during at least the last three decades.

So big was it that very few expressed some concerns about that it could dangerously distort the allocation of credit to the real economy.

So big was it that when with Basel I, 1988, it decreed a risk weight of 0% for the sovereign and 100% for the citizens, no one shouted, “You’re just a bloody bunch of statists/communists!”

So big was it that when 2004, with Basel II, no one found something wrong with a risk weight of 20% for AAA rated assets, that which bankers could love too much, and one of 150% for what is rated below BB-, that which bankers would not touch with a ten feet pole.

So big was it that when the 2007/08 crises broke out solely because of excessive bank exposures to assets that required banks to hold almost no capital, like AAA rated securities and sovereigns like Greece, the world screamed about the effects of “deregulation” and said not a word about “miss-regulation”.

So big was it that the Frank-Dodd Act, in its 848 pages, did not even mention the Basel Committee. And when that Act mentions risk weighing, no real concern is raised, but other risks that should also be included are pointed out.

So big was it that all type of efforts are being put in trying to make the credit ratings better, ignoring the clear danger present when there is even more trust put into these ratings.

So big was it that all those who had anything to do with it, like Mario Draghi, were promoted.

So big is it that basically every day we hear statements on banks being adequately capitalized, comparing current risk weighted oranges with former apple capital ratios that had no such thing.