Saturday, March 5, 2016
Right now, with the risk weighted capital requirements banks, need to hold more capital against what is perceived as risky than against what is perceived as safe. That presumes bankers are blind, dumb and suicidal. And that’s what’s really dangerous.
The real ex post dangerous consequence of something goes down the riskier it is perceived ex ante. The real ex post dangerous consequence of something goes up the safer it is perceived ex ante.
So, if you want to introduce risk weighted capital requirements, then the real question you as a regulator need to answer is: What are the chances banks create large dangerous excessive exposures to something ex ante perceived as safe, when compared to doing the same against something perceived as risky?
And the answer to that would indicate the current capital requirements for banks are 180 degrees wrong. But regulators don’t seem to care.
And the real consequence of that mistake is not only to expose banks to stand there with little capital precisely when they need it the most, but also to dangerously distorts the allocation of credit to the real economy.
The regulators, by allowing banks to leverage much more with assets perceived as safe, allow banks to earn higher expected risk adjusted returns on equity on what is perceived as safe, than on assets perceived as risky.
And so, as a direct consequence, millions of “risky” SMEs and entrepreneurs, those who anyhow would have gotten smaller loans and paid higher risk premiums, have been denied fair access to bank credit.
And so, as a direct consequence of that, tens or even hundred of millions of jobs around the world and that could have benefited the next generation, had no chance of being created.
And all for nothing as the truly dangerous bank crises keep on resulting, as always, from excessive exposures to something erronously perceived as safe… like AAA rated securities.
And all this while regulators keep on congratulating themselves for how smart they are.