Wednesday, August 19, 2015

How to blow up the banking system

Q. What is the most dangerous for banks?

A. That they build up excessive dangerous exposures to something that turns out much riskier than they expected

Q. When do banks usually build up such exposures?

A. Obviously when they perceive something as very safe and they expect to make very good returns on it.

Q. And what else can make those excessive bank exposures especially dangerous, for instance for the taxpayers?

A. That the banks, if something goes wrong, stand there almost naked with very little equity to cover the losses.

Q. So hypothetically, mind you, what would you think of credit-risk weighted capital requirements for banks that are especially low for what is perceived as safe?

A. Well, since that would allow banks to earn the highest risk adjusted returns on what is perceived as safe, it would therefore, sooner or later, cause banks to build up dangerously excessive exposures to what is perceived as safe against very little capital, and so it sure sounds like the perfect way to blow up the banking system..... Sir, excuse me, why do you ask all this?

PS. 1999 in an Op-Ed I wrote: “The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause it collapse”

Note: My January 2009 AAA-Bomb blog