Wednesday, March 11, 2015

The Basel Committee does not yet even acknowledge the biggest mistake with risk-weighted capital requirements

The Basel Committee on Banking Supervision has issued a Consultative Document on “Revisions to the Standardised Approach for credit risk” and that it wants responses to before March 27 2015.

“In seeking to enhance the current standardised approach for credit risk, the Committee has identified a number of weaknesses that the proposals set out in this consultative document aim to address, namely: 

Over-reliance on external credit ratings 
Lack of granularity and risk sensitivity 
Out-of-date calibrations 
Lack of comparability and misalignment of treatment with exposures risk weighted under the IRB approach 
Excessive complexity and lack of clarity within the standards 

As you can see the document does not even acknowledge the most fundamental error with current portfolio invariant credit-risk based equity requirements for banks.

In a free market perceived credit risks are cleared for by interest rates, size of exposure and other contract terms.

But by allowing some assets (the safe) to be held against less equity than other (the risky) the perceived credit risks will now also be cleared for regulatory equity requirements, something which completely distorts the allocation of bank credit to the real economy.

The real net interest margins paid by those perceived as "safe" will, as bank equity can be leveraged much more with these, be worth much more than the real net interest margins paid by those perceived as risky and for which bank equity can be less leveraged.

That introduces an odious regulatory discrimination in favor of what is perceived as safe, that which is already favored by the markets, because they; and against that perceived as risky, that which is already disfavored by the markets.

The regulators are so utterly mistaken looking at the risk of a bank’s assets. What the regulator should be looking at is at the risks of bank assets not being correctly perceived and or correctly managed.

ASAP the Basel Committee must eliminate credit-risk weighted bank equity requirements which, on top of producing dangerous distortions serves no stability purpose either… since never ever have major bank crises resulted from excessive exposure to something ex ante perceived as risky, these have all, no exceptions resulted from excessive exposure to something ex ante erroneously perceived as safe.

I have been criticizing these regulations but the Basel Committee has refused to even listen.

All what this document proposes seems only to be digging our banks deeper and more complexly into the for our economies so dangerous risk-adverse hole they find themselves in.

And meanwhile the safer assets which banks have ben instructed to compete with pension funds widows and orphans for, are becoming scarcer by the second.

Neither Hollywood nor Bollywood would allow scriptwriters, producers, directors and actors of a box office flop like Basel II, to proceed to work as if nothing on a Basel III.