Monday, April 11, 2016
On March 31, 2016 William C Dudley of the Federal Reserve Bank of New York, gave a speech titled “The role of the Federal Reserve – lessons from financial crises”
There are many issues I do not agree with in that discourse but let me here concentrate on “lessons from financial crisis”.
Mr Dudley stated: “The crisis showed that the regulatory community did not fully grasp the vulnerability of the financial system. In particular, critical financial institutions were not resilient enough to cope with large scale disruptions without assistance, and problems in one institution quickly spread to others.”
Not a word about how the risk-weighted capital requirements for banks; which permit banks to leverage more on what is perceived, or has been decreed, or has been concocted as safe, than with what is perceived as risky; which means banks earn higher risk adjusted returns on equity on what is "safe" than on what is “risky”; which means banks will lend too much to what is “safe”, like sovereigns and the AAArisktocracy, and too little to what is “risky”, like SMEs and entrepreneurs.
And anyone who has still not understood the dangers that distortion of the allocation of bank credit poses to the banks, and to the real economy, doest not have what it takes to work on bank regulations.
The main lesson here is: It was the regulators who, by allowing banks to hold less capital against precisely the stuff that all major bank crisis are made of, namely what is ex ante perceived as safe, made the banking sector more vulnerable.