Friday, August 26, 2016

There are three causes for major bank crises. Regulators focused on one that’s not. Basel Committee & FSB... Good Job!

What are the causes of major bank crises?

1. Unexpected events, like major devaluations and natural disasters.

2. What was ex ante perceived as very safe turned out ex post to be very risky.

3. Shenanigans like unauthorized speculative trading or banks lending to their own directors or shareholders.

What did the regulators do? 

They introduced credit-risk-weighted capital requirements: more ex ante perceived risk more capital - less risk less capital... clearing agains for basically the only risk that was already being cleared for, by means of size of exposure and interest rates.

For instance, prime AAA to AA rated got 20% risk weight ,while the highly speculative almost broke below BB- rated, got a 150% risk weight...

As if banks would ever build up dangerous excessive exposures to what is below BB- rated 

Good job regulators!