Sunday, January 19, 2014

A simple question, on bank regulations, to Basel Committee, Financial Stability Board, FED, ECB, FDIC, PRA and other

Do you really believe that those “unexpected losses” which could destabilize the banking system, should be estimated based on the estimations of “expected losses”? 

I ask that because that is what you have, in my opinion irresponsibly so, bet our whole banking system on... in fact even bet the health of our real economy on.

The capital requirements for banks should primarily cover for any unexpected losses, as any expected losses should primarily be covered by bankers knowing what they are doing. But, by your own confessions you have based the unexpected losses on the perceived risk of expected losses, like those contained in a credit rating. And that leads to the expected losses to be counted twice, while the unexpected losses are not considered at all.

And to top it up your current capital requirements for banks are, again by your own confessions, “portfolio invariant”, which means that the benefits of asset diversification among “the risky” or the dangers of excessive concentration of assets to something perceived as “absolutely safe” are not considered at all.

What you have done allow the banks to earn much higher risk-adjusted returns on capital when lending to The Infallible than when lending to The Risky, and this seriously distorts the allocation of bank credit in the real economy, with tragic implications for its future health.

And all for nothing, because you should know that what can cause the unexpected losses that can really bring a banking system down, are really to be found among what is perceived to generate the lowest expected losses.

What can I say regulators? That you have no idea of what you are up to? Frankly, I can’t find any other explanation.

You have a lot of explaining to do all that unemployed youth that you might turn into a lost generation. 

You fill pages after pages with talk about prudential regulations, but let me remind you of that the first rule of prudence is to cause not even larger damages! And that you have done.