Sunday, December 25, 2016

Harvard Law School. I hope you did not believe Bill Coen with that the Basel Committee knows what it’s doing.

Bill Coen, the Secretary General of the Basel Committee on Banking Supervision, spoke at the Harvard Law School on December 12, 2016. In: “The global financial crisis and the future of international standard setting: lessons from the Basel Committee” Coen had this to say about the metric of the risk-weighted ratio:

“Its strength is that it sets capital requirements according to the perceived riskiness of a bank’s assets.” 

Comment: It is sheer lunacy to set capital requirements according to ex ante perceived risks, when you should set them according to the risk that banks might not adequately perceive the riskiness of their assets. In fact all bank crises have occurred from unforeseen events (like devaluations), criminal behaviors or excessive exposures to what ex ante was perceived as safe but that ex post turned out to be risky. No bank crisis has ever resulted from excessive bank exposures to something ex ante believed risky.

“Its weakness is that it is susceptible to setting too low capital requirements, either unintentionally (model risk), or intentionally (gaming).”

Comment: This evidences mindboggling naiveté. For banks to earn the highest possible risk adjusted returns on equity, they will automatically look to hold as little equity as possible. So it is like placing some delicious cookies in front of children, and expecting them to reach out for the spinach.

Students and professors at Harvard Law School, do us all a big favor. Send Bill Coen the following questions, and ask him formally to respond. At least that would save me from having to go on a hunger strike or other similar extremes in order to get some answers.

PS. You could also ask the Harvard Business School about why they have kept such silence on the monumental mistakes of current bank regulations.