Wednesday, February 4, 2015

A proposal to the Office of Financial Research (OFR) about some urgent research needed on the causes of bank crises.

I extract the following from the webpage of the Office of Financial Research (OFR) established by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 in order to support the Financial Stability Oversight Council, the Council’s member organizations, and the public.

“OFR helps to promote financial stability by looking across the financial system to measure and analyze risks, perform essential research, and collect and standardize financial data.

Our job is to shine a light in the dark corners of the financial system to see where risks are going, assess how much of a threat they might pose, and provide policymakers with financial analysis, information, and evaluation of policy tools to mitigate them.”

I have a very important research that I would suggest the OFR to take on, as soon as possible. It is a follows:

One of the pillars of current capital requirements is portfolio invariant credit-risk-weighted equity requirements for banks, also less transparently known as “risk-weighted capital requirements for banks”.

And this regulation in general terms requires banks to hold more equity against assets perceived as risky than against assets perceived as safe.

And since that introduces a discriminatory distortion factor in the allocation of bank credit, something that could prove very dangerous to the real economy, the only possible justification is of course that what is perceived as risky carries more dangers for the system than what is thought safe.

I do not believe that. Of course that could be true for some individual banks but, for the bank system at large, I hold that it is what ex ante is perceived as very safe, but that ex post can turn out to be very risky that poses the real dangers.

And in this respect it would be very important for the US, as well as for the world, to research what perceived credit risks could be identified as having caused major bank crisis. Of course I do not mean an ex-post analysis, but an analysis of the perceptions on credit risk present at the moment banks incorporated the later troublesome assets on their balance sheets.

As you can understand, if my opinion is proven right, then current regulations would, in principle, be 180 degrees off target.