Saturday, April 22, 2017

Should not science matter to bank regulators, at least a little?

I ask because though I am no scientist, far from it, have never really understood Einstein’s relativity theory, I know that if I were asked to regulate banks there would be two basic questions I would have to ask:

First, what is the purpose of our banks? Quite early someone would have mentioned John A Shedd’s “A ship in harbor is safe, but that is not what ships are for” and I would have ascertained that purpose to be, to allocate credit to the real economy, carefully but efficiently. 

Second, what has caused major bank crises? a. Unexpected events, like devaluations, b. criminal behavior, like lending to affiliates; and c. dangerously large exposures to something ex ante perceived as very safe but that ex post turned out to be very risky. Surely someone would have also cited Voltaire’s “May God defend me from my friends, I can defend myself from my enemies” as a reminder that what is perceived as risky is, precisely because of that perception, quite innocuous.

After that initial mini research, the last thing I would have come up with is the current risk weighted capital requirements, more risk more capital – less risk less capital, that which distorts the allocation of bank credit, for no stability purpose at all... much the contrary.

So again… should not science matter to bank regulators, at least a little?