Thursday, December 25, 2014
If credit risks are correctly perceived by banks, one or another bank could still run into problems, but there will be no major bank system crises. It is when credit risks are incorrectly perceived that things with our bank system can get really bad.
So what the Basel Committee for Banking Supervision has done, which is creating credit risk weighted capital requirements for banks, based on as if the perceived risks are correct, makes absolutely no sense. If anything those capital requirements should have been based on the possibilities of those credit risks being more risky than what they are perceived to be.
But the impact of all credit risk perceptions being wrong, is not the same over the whole spectrum of risks. In fact bank regulators ignored what I quite presumptuously have decided to dub the Per Kurowski rule; namely that the more the credit risk perception is one of safeness, the larger the negative impact on a bank if that perception turns out to be wrong.
That rule should be easy to understand when one realizes that it is for what is considered as very safe, that a bank most runs the risk of running up too high exposures, in too lenient terms, and charging too little compensating risk premiums.
The impact on banks of what is considered as risky, if it turns out to be more risky, is ameliorated by the fact that it usually represents smaller exposures, and usually belongs to a group of exposures which are mutually covered through much larger risk premiums.
Since different capital requirements allows some assets to produce higher risk-adjusted returns than others, and that distorts the allocation of bank credit to the real economy, I favor one single percentage capital requirement for all bank assets.
But, if regulators absolutely feel they must meddle, in order to show they earn their salaries and their societal recognitions, then they should at least abandon the current capital requirements based on credit risk weighting, in favor of an impact weighting of credit risks being wrongly perceived.
What would this mean in practice? That our banks would again be allowed to lend to the risky but tough small businesses and entrepreneurs we all need to get going when the going gets tough.
In other words… just what a doctor would order, for example for Europe… and so that banks can help to produce the next generation of jobs for the next generations of Europeans.
Intuitive decision: Perceived safe is safe, perceived risky is risky.
Deliberate decision: Perceived safe is risky, perceived risky is safe.
PS. Per Kurowski's second rule: Any perfectly perceived credit risk, causes wrong credit decision, if the perceived risk of credit is excessively considered.