Our banks… a bad road leading from nowhere to nowhere!

A road can be extremely well constructed but lead from nowhere to nowhere. That is why it so extraordinary that we allow the global regulators in the Basel Committee to regulate our banks without defining a purpose for our banks. That said, since the Basel Committee proved that it was not even good at regulating basic road engineering, we now have a bad road coming from nowhere and leading to nowhere.

Let me explain why besides lacking a purpose, the regulations of our banks are so lousy.

The only risk the regulators considered in order to set the capital requirements for the banks in Basel II was the risk of default of their clients, mostly as this was perceived by the credit rating agencies. The higher the perceived risks, the higher were the capital requirements and vice versa.

The above though sounding logical completely ignored that the market already arbitrages for the information provided by the credit rating agencies about risk of defaults, by means of adjusting the risk-premiums it applies. Therefore, the unforeseen but should have been foreseen results of these capital requirements based on risk, was to dramatically increase the risk-adjusted return on bank capital when lending to anything perceived as “not-risky”, while making it, in relative terms, dramatically much less attractive to finance anything officially perceived as “risky” and that for its same adjusted risk premium requires more bank capital.

No wonder that the banks stampeded into the triple-A rated waters where, since real triple-As are and will always be extremely scarce or non-existent, the market had provided some Potemkin triple-A ratings.

The only real Black Swan event that caused this crisis was that amazingly inept regulators got hold of the Basel Committee… and the most amazing thing is that they are still there!