Wednesday, May 24, 2017

Fortunetellers’ bankers' bad-luck weighted capital requirements for banks would be better than Basel Committee’s risk weighted

We have the Basel Committee’s risk weighted capital requirements for banks. More ex ante perceived risk more capital, less perceived risk less capital. These are loony. First since it considers that was is already perceived as risky, is riskier for the bank system than what is perceived as safe; and second because it distorts the allocation of bank credit to the real economy, hindering banks from the much needed financing of the riskier future, making them concentrate on refinancing the safer past and present. 

Now, if we were to weigh the capital requirements for banks based on the fortunetellers reading bankers' hands, to ascertain bankers' bad-luck, then we would at least have one capital requirement against all assets; something that would at least not distort the allocation of bank credit to the real economy. And since this procedure would be based on bad-luck, and not on good luck, we could expect that capital requirement to be fairly high.

And if the fortunetellers got it all wrong, since they did not distort credit allocation, that would be less dangerous when compared to the credit rating agencies being wrong.

I challenge any of all current bank regulators to, in public, defend their risk weighting against that of my fortunetellers.

My opening question to them would be: What do you think of that Basel II assigned a risk weight of only 20% to the so dangerous AAA rated, and one of 150% for the so innocuous below BB- rated?

PS. Of course fortunetellers could be captured... but so can credit rating agencies be too.

PS. Now, what I would not suggest to do, is to allow big banks to use their own internal fortunetellers, as they currently use their own internal risk modellers to weigh the risks, and thereby set the capital they are required to hold.

PS. Of course, if we land ourselves a fortuneteller that wants to show-off, and for instance insists on that bad-luck depends on the day of the week a credit is approved, we better look for a less sophisticated one.