Thursday, January 12, 2017

Do bank regulators, now with “output floor” based on their standardized risk weights, keep on making fun of us?

A 75-percent output floor signifies that no matter which outcome the bank’s internal calculation yields, the risk weight that determines the capital required, can’t be more than 25 percent lower than the standardized risk weighting method designed by the regulators.

So let’s see what that really means. 

For the standard method’s 0% risk weighted sovereign, unless some bank’s internal calculation comes up with a negative risk, it will still mean 0%.

For the standard method’s 20% risk weighted private asset, it means the weight cannot be less than 15%.

For the standard method’s 35% risk weighted residential mortgage, it means that weight cannot be less than 26.25%.

For the standard method’s 100% risk weighted private asset without a credit rating, like loans to SMEs, it means that the risk weight cannot be less than 75%.

Really? Are bank’s internal models worse than your standardized weights? Do you really think the Medici’s would have assigned a risk weight of 0% to the Sovereign?

There’s absolutely nothing wrong with allowing banks to use their own risk models in order to try to minimize their cost of capital, but that regulators concoct a set of ex ante perceived standardized risk weights in order to determine how much capital banks should have in order to be able to confront, not perceived risks, but uncertainty, is just as crazy as it gets.

Here some questions bank regulators refuse to answer, something that should make us all nervous. They really might not have a clue about what they are doing.