Mme Lagarde. With regulations that distort the allocation of bank credit, any recovery is on shaky grounds.

Sir, I refer to Chris Giles’ “IMF chief warns of risks to recovery” July 6.

Of course, with regulations that distort the allocation of bank credit to the real economy, any recovery is on shaky grounds.

To help Mme Christine Lagarde of the International Monetary Fund understand the issue, better, I have drafted a short and polite letter she could send to her friends the regulators in the Basel Committee and the Financial Stability Board. Their answer, or their no answer, should reveal a lot. 

Dear regulator.

You set your risk-weighted capital requirements based on the ex ante perceived risks already considered by bankers when determining the size of the exposure and the risk premiums to charge. Could that not imply that perhaps the ex-ante perceived risks are excessively considered?

I often wonder if it would not be wiser of you and your colleagues to set these based on those risk not having been adequately perceived, or that bankers are not capable of manage the risks they perceive; or with an eye to somewhat unlikely but nevertheless potentially catastrophic events.

You and I know that one vital function we expect our banks to perform is to allocate credit efficiently to the real economy. Remembering that context, I wonder if the risk weighting you and your colleagues customarily make in your regulatory function is perniciously, if also unintentionally, distorting capital allocation -- by favoring the safer? past over the riskier? future?

Sincerely,

PS. If they do not answer Mme Lagarde could find a summary of some of the mistakes with risk weighting here.

@PerKurowski