Monday, October 31, 2016
For about 600 years, before 1988, the exposures of banks to assets were a function of the by bankers ex-ante perceived risks (bpr), the risk premiums (rp), and bankers’ risk tolerance (brt)
Pre 1988 Bank exposures = f (bpr, rp, brt)
Bank capital (equity) followed the rule of "One for all and all for one".
After 1998, Basel Accord, soon 30 years, with the introduction of the risk weighed capital requirements, the exposures of banks to assets are a function of the by bankers ex-ante perceived risks (bpr), the risk premiums (rp), bankers’ risk tolerance (brt), and regulatory capital requirements (rcc), this last itself a function of the by regulators ex-ante perceived (or decreed) risks (rpr) and the regulators' risk tolerance (rrt)
After 1988 Bank exposures = f (bpr, rp, brt, rcc=f (rpr, rrt))
Anyone thinking banking remained the same after 1988 is either naïve or dumb.
Anyone thinking the allocation of bank credit to the real economy was not distorted by this, is dumb.
Anyone thinking that distorting bank credit to the real economy is not something very risky, is either ignorant or a populist technocrat suffering from excessive hubris.
Anyone thinking that distorting bank exposures this way make banks safer, is an ignoramus who has no idea about what bank crises are made of: namely unexpected events, criminal doings and what was ex ante perceived as very safe but that ex post turned out very risky.
PS. With respect to the perceived risks, both the bankers’ and the regulators, let me remind you that any risk, even if perfectly perceived, causes the wrong actions if excessively considered; something here done by design.