Saturday, January 5, 2013

Who can explain the absolute absurdity of Basel II bank regulations?

If bankers knew how to manage risks perfectly there would be no need for bank capital. But, since they don’t, the regulators naturally require banks to have some capital. 

But when bankers get it wrong managing risks that are perceived as high, this does normally not cause any problems. In that case the exposures to the high-risks are small, the terms of contract quite strict and the interest rate already includes a high risk-premium. 

It is when bankers’ get it wrong managing risks which are perceived as almost non-existent, that shit really hits the fan. In this case the exposures are huge, the risk-premiums low and the contract terms quite often too generous. 

And so it would seem that any prudent regulator would ask the bank to have some reasonable capital, let us say 8 to 10 percent, especially against all the assets perceived as “absolutely not risky” 

But what did the Basel regulators do with Basel II? They decided that if a bank lends to one of “The Infallible”, the potentially really problematic lending, it can do so holding only 1.6 percent in capital, 5 times less than the 8 percent capital it is required to have when lending to “The Risky” the usually non-problematic lending.