The risk weighted capital requirements for banks, is the most potent steroid ever for having to suffer some truly bad “Minsky moments”.
Sir, John Plender correctly writes: “If Hyman Minsky were alive today, he would regard the current economic cycle as a testing ground for his instability hypothesis. That which holds the financial system has an innate tendency to swing from robustness to fragility because periods of financial stability breed complacency and encourage excessive risk-taking.” “Complacent investors face a Minsky moment as pendulum swings” November 14.
But what Plender does not mention, perhaps because it belongs to that which shall not be mentioned, is the greatest procyclical pro-Minsky-moment steroid ever, namely the risk weighted capital requirements for banks.
When times are good and credit rating outlooks are sunny, that regulation allows banks to leverage immensely with what’s perceived as safe but, when a hard rain seems its going to fall, and credit ratings fall, all recessionary implications are made so much worse by banks then, suddenly, having to hold much more capital… and since such capital might be hard to find during bad times, they take refuge in whatever is still perceived, or decreed as in the case of sovereigns, to be of less risk… just increasing the stakes
Plender writes: “It is historically atypical in that central banks have been encouraging deflationary threat”. Really? At least with respect to banks they have encouraged these to build up ever-larger exposures to what’s perceived as safe, like residential mortgages, or to what’s decreed as safe, like loans to friendly sovereigns.
@PerKurowski
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