Sunday, January 30, 2011

We need bank regulators who do not believe themselves the risk-managers of the world

I refer to the Financial Crisis Inquiry Final Report, issued January 2011 by The National Commission on the Causes of the Financial and Economic Crisis in the United States.

Unfortunately, though it contains much valuable information and analysis, the report does not identify the fundamental cause of the crisis, namely that the bank regulator, primarily the Basel Committee, with amazing hubris, took upon itself to act as the risk-manager of the world.

In effect, when the Basel Committee set capital requirements for banks imposing risk-weights based on its arbitrary perception of the risk reflected by the credit ratings issued by the credit ratings agencies, it de-facto determined what was to be ground zero for most other risk-managers.

In effect, it was precisely those capital requirements for banks that tempted too much the banks to enter excessively and with minuscule equity life vests the triple-A waters, where they drowned.

In effect, those arbitrary capital requirements cause an odious and regressive discrimination requiring from those perceived as risky and who already pay higher interests rates, to carry an inordinate weight of the capital requirements of banks that is needed to support the system; effectively subsidizing those perceived ex-ante as having “low risks” and who therefore already pay lower interest rates.

In effect, from a regulatory point of view those capital requirements based on perceived risks, are plain silly, knowing that what causes systemic disasters in banking are always those risks that have not been perceived or are ignored by the collective.

It is very urgent we throw out the paradigm of capital requirements for banks based on perceived risk of default, which only distorts the markets and serves no purpose at all. But that will not happen until the problem is fully understood, and sadly it looks like, with this report, that the world missed another good opportunity.