Tuesday, February 10, 2015

Why do so many finance reporters and professors seemingly participate in the cover up of the greatest regulatory mistake of all times?

The risk of a bank to a regulator is that the credit risk of a bank client is not correctly perceived, or that the bank is not able to adequately manage that perceived credit risk, in the context of its portfolio. Even so regulators set the equity requirements for banks solely based on the ex ante perceived credit risks of the clients of the bank, and as if these perceptions were correct. Something really dumb!

But, if you use credit risks to set equity, then you should at least have been able to ascertain that it is what’s perceived as “safe” which has caused all major crises in the banking system, and never ever what has ex ante been perceived as “risky”. Even so regulators set much lower equity requirements for banks for what was perceived as safe than for what was perceived as risky. Doubling up on their dumbness! 

Regulators should also have known that the most important purpose of a bank is to allocate credit as efficiently as possible to the real economy. And even so, by allowing equity to be leveraged differently for different assets, and thereby skewing the risk-adjusted returns on equity, they caused that process to be distorted. Something really irresponsible!

And I have held for years that it all adds up to the mother of all regulatory mistakes. And the ones most responsible for it is the Basel Committee for Banking Supervision, the Financial Stability Board and the International Monetary Fund.

And it is very understandable that those regulators who are to be blamed for this monstrous mistake that not only caused the current crisis but also keeps our economies from finding the way out of it, want it to be ignored, forever and at whatever cost.

It is also easy to see why bankers do not comment on the mistake. To be allowed to earn the highest risk adjusted returns on equity when lending to something perceived as “absolutely safe”, must be a banker’s dream come true.

It is also easy to understand why politicians have not gotten involved. To begin with the “more-risk-more-capital and less-risk-less-capital” sounds so damn sensible. And to understand that when regulators speak of “risk-weighted capital requirements” they are actually speaking of “portfolio-invariant-ex-ante-perceived-credit-risk-weighted bank equity requirements” requires more reading than what they are used to in these PowerPoint days.

But that financial reporters and finance professors should keep mum about it all, effectively participating in the cover up, that to me is just plain incomprehensible.

And that those perceived as “risky” are not aware of how they are being so odiously discriminated against in their access to bank credit, that is just very sad.

I just pray some of the younger generation stands up and shouts out “That silly regulatory risk aversion is stopping our banks from financing that future we are supposed to live on!” 

PS. Look at poor Greece where greedy bankers and corrupt Greek governments are being blamed, with not a word about the fact that European regulators allowed banks to lend to Greece against no capital at all… which only could lead to Greece borrowing way too much.