Friday, December 11, 2015

The Basel Committee insists in not caring one iota about whether its risk-weighted capital requirements distort the allocation of bank credit to the real economy.

In December 2015 The Basel Committee on Banking Supervision has now released its “Second consultative document: Standards: Revisions to the Standardised Approach for credit risk”. It is issued for comments by March 11, 2016.

The introduction states: “This is the Committee’s second consultation on Revisions to the Standardised Approach for credit risk. The Committee wishes to thank all respondents for their extensive feedback on its first consultative document, which was published in in this second consultative document aim to address the issues raised by respondents with respect to the initial proposals. These revised proposals also seek to achieve the objectives set out in the first consultative document to balance simplicity and risk sensitivity, to promote comparability by reducing variability in risk-weighted assets across banks and jurisdictions, and to ensure that the standardised approach (SA) constitutes a suitable alternative and complement to the Internal Ratings-Based (IRB) approach.”

I was one of very few citizens who responded to their first consultative document, and my objections have not been even remotely considered much less responded to. I ended then my comments with:

“Regulators, please, before you keep on regulating, go back and define the purpose of banks. It has to be more than to just be safe mattresses. It has to at least include not distorting the allocation of bank credit. 

With these credit risk adverse regulations, banks are financing less and less the risky future; and only refinancing more and more the safer past. That has to stop, for the good of our children and grandchildren. “A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926 

In 1999, in a Op-Ed in 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 the collapse of our banks'. 

We have already seen too many low-risk-weights AAA bombs detonate with disastrous consequences. So when are you bank regulators going to stop trying being the self appointed risk managers for the world? You’re doing a lousy job at it, and not being held accountable for it.”

And so with this 2nd consultative document it is clear that the Basel Committee still does not care one iota about whether their risk-weighted capital requirements distorts the allocation of bank credit to the real economy.

And it is clear that the Basel Committee is still utterly fixated on the risks of bank assets and ignore the much more important risk of whether banks can adequately manage those perceived risks. In day-to-day terms they find motorcycles to be much more dangerous than cars for the system, even though many more die in car accidents than in motorcycle accidents.

And it is clear that they are still trying to base the capital banks should primarily hold against unexpected losses, on estimates about the expected credit losses. And it is clear they cannot understand that the safer something is perceived the larger the potential of it to deliver unexpected bad news.

And since expected credit risks are already cleared for by banks with interest rates and size of exposures, the Basel Committees insistence on also clearing for those risks in the capital requirements, evidences they have no understanding of that any risk, even if perfectly perceived, will cause the wrong actions if excessively considered.

The way the Basel Committee has seemingly circled its wagons against any outside real criticism, I am not too optimistic about my chances to influence them. Nevertheless I have to try doing so, and so I will send them these comments and perhaps some others before March 11, 2016.

PS. Since they also refer to the use of credit rating agencies, let me quote a letter I wrote and that was published in the Financial Times January 2003. It included: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds. Friends, as it is, the world is tough enough.”

And so, if anything, it would be much more logical to make the capital requirements for banks based not on the credit ratings being correct, in which case there is no problem, but based on the possibilities of credit ratings being wrong… let us say about 8 percent on all assets.

PS. Do I have any credential to be opining here? I think so. As an Executive Director of the World Bank 2002-2004, in October 2004, in a formal statement I wrote: "We (I) believe that much of the world’s financial markets are currently being dangerously overstretched through an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions"