Tuesday, January 22, 2013

If I was the FDIC, I would ask bank regulators two questions

If I was the Federal Deposit Insurance Corporation, mandated to insure depositors for when banks fail, I would not lose one minute of sleep concerning myself with bank assets perceived as “risky”, but I would certainly toss and turn all night, thinking about assets that are perceived as “absolutely safe” and might not be. 

“The Risky” assets those take care of most of my risks on their own, by means of lower bank exposures, higher interest rate premiums and tougher contract terms. 

It is always “The Infallible” assets which represent the really expensive dangers to me, since if these assets, as sometimes happens, ex-post turn out to be very risky, then the bank exposures are usually enormous, the earned risk premiums much too low, and the contracting terms much too lax. 

And so, if I was the FDIC, I would ask the current bank regulators about what they are thinking when they allow banks to hold so much less capital against “The Infallible” than against “The Risky”. 

And since if I was the FDIC, and therefore also responsible for “promoting sound public policies … in the nation's financial system”, I would also ask the regulators whether allowing banks to leverage their equity much more when lending to “The Infallible” than when lending to “The Risky”, does not introduce distortions that make it impossible for the banks to assign resources in the real economy, with any type of efficiency.

In short, if I was FDIC, current capital requirements based on perceived risk would be completely unacceptable.