Tuesday, August 21, 2012

Mr. Bank Regulator. Please explain yourself!

In banking (as with most in life) with respect to perceived risks, there are only four possibilities: 

Risky/risky: What was perceived as risky turns out to be risky. Because of the higher interest rates usually charged to those perceived as risky, which serves as a shield, the harsher terms, and the lower bank exposures that follow, this quadrangle has never ever been the source of any major bank disaster. 

Risky/not-risky: What was perceived as risky turn out not to be risky. This can only be of course, a source of good news. 

Not-risky/not-risky: What was perceived as not-risky turn out not to be not-risky. In other words, all as expected. 

Not-risky/risky: What was perceived as not risky, turned out to be risky. This is of course the only source of all major bank crises, namely when major bank exposures gone sour. 

But, the current “pillar” of bank regulations, is capital requirement for banks which allow for much less bank capital when lending in the danger area of the perceived “not-risky”… and that does not seem too smart. 

Not only will the increased possibilities of leveraging bank equity attract too much bank interest in lending to the “not-risky”, but also, when things go sour, the banks will stand there naked, with little or no capital. And it also creates a regulatory disincentive for banks to lend to the safe area of the perceived as risky… and which by the way includes the small businesses and entrepreneurs we so much need to have access to bank credit. 

Indeed that regulation sounds very dumb, which leads me having to consider you, as a bank regulator, to be very dumb. I have for almost a decade now tried to get an explanation from you, but you have consistently refused to do so. You have not even acknowledged the arguments. And so, here is a new opportunity for you to explain yourself. 

Let me assure you that I would love for you to be able to convince me that, with your regulations, you are not castrating our banks, that important channel by which a risk adverse society takes the risks it needs for it to take, without making these safer, but in fact even endangering these. 

What’s my problem? I tell you! If you would run a regression between all the obese bank exposures that have lately gone bad, and the extremely low capital requirements allowed banks for holding these assets, one should conclude that your dumb regulations fundamentally caused this crisis. And, for that, you need to be held accountable, most especially when you seem quite unwittingly to be digging our economies even deeper in the hole. 


Per Kurowski