One of Basel Committee’s many monstrous regulatory mistakes made easy. The expected and the unexpected mix up.

As regulators have explicitly stated, banks should be required to have capital (equity) as a cushion against unexpected losses. 

In Basel II, the risk weight applied to assets of private corporations rated AAA to AA, was 20%. This weight, applied to a base capital of 8%, signified banks had to hold 1.6% in capital against these “safe” assets. And the correspondent risk-weight for assets rated BB- and below, was 150%, which meant banks had to hold 12% in capital against these “risky” assets.

Let me ask anyone of you… what carries a larger potential of dangerously high-unexpected losses, what is rated AAA to AA, or what is rated below BB- and for which therefore the expected losses are huge? 

Do you get the drift?

Also, the moment a risk is generated for a bank is not when an asset is down-rated, but when that asset is put on the bank’s balance sheet. But currently it is when a credit gets down-rated that regulators, much too late, jack up the capital requirements; something which makes it even more difficult for banks to manage the problem assets.

PS. This is one of the many observations regulators have steadfastly refuse to comment on. If anyone of you is able to extract something of an answer from these not accountable to anyone regulators, I would be grateful to know about it.