Saturday, March 28, 2015

Would the Basel Committee or the Financial Stability Board approve the following exam question?

Suppose they ask you to calculate the risks of accidents in crossroads, and you based it on how drivers suffer accidents in general. Would you pass the exam? I don’t think so.

I ask this because the Basel Committee, when setting their equity requirements for banks, based it on the risks that bank borrowers would fail, and not on the risks that banks would fail.

And based on that they allow banks to hold less equity when lending to "the safe" than when lending to "the risky.

Something like allowing drivers with good driving records to speed faster through the crossroad than more accident prone drivers… even though records would show that it is precisely when drivers drive too fast through a crossroad, or the lights are malfunctioning, that the worst accidents occur. 

Scary eh!