The Basel Committee for Banking Supervision’s tragic mistake of doubling down on perceived credit risks

Bankers manage the expected losses by means of perceiving credit risks. And if they are not good at it, they should fail.

Bank regulators on the other hand, need to impose equity requirements on banks to cover for unexpected losses. That is in order to create a buffer between a bank’s operations and the needs for taxpayers’ assistance.

Unfortunately, don’t ask me why, the Basel Committee for Banking Supervision imposed equity requirements on banks that are also based on perceived credit risks, more-risk-more-equity and less-risk-less equity.

That signified a doubling down on credit risk perceptions. And any risk, even when correctly perceived, can create much havoc, if it is given too little or too much importance.

As a consequence current allocations of bank credit to the real economy are utterly distorted, by favoring those perceived as “safe” and punishing those perceived as “risky”.

And also banks will most certainly have insufficient equity to cover for unexpected losses, simply because, the “safer” a borrower seems ex ante, the greater the possibility for the unexpected to cause truly huge disasters, ex post.

And this mistake that has been around for about 25 years, even after disaster struck, is still as of today, not yet even acknowledged by those responsible for it.