One of Basel Committee’s many monstrous regulatory mistakes made easy. The expected and the unexpected mix up.

As regulators have explicitly stated, banks should be required to have capital (equity) as a cushion against unexpected losses. 

In Basel II, the risk weight applied to assets of private corporations rated AAA to AA, was 20%. This weight, applied to a base capital of 8%, signified banks had to hold 1.6% in capital against these “safe” assets. And the correspondent risk-weight for assets rated BB- and below, was 150%, which meant banks had to hold 12% in capital against these “risky” assets.

Let me ask anyone of you… what carries a larger potential of dangerously high-unexpected losses, what is rated AAA to AA, or what is rated below BB- and for which therefore the expected losses are huge? 

Do you get the drift?

Also, the moment a risk is generated for a bank is not when an asset is down-rated, but when that asset is put on the bank’s balance sheet. But currently it is when a credit gets down-rated that regulators, much too late, jack up the capital requirements; something which makes it even more difficult for banks to manage the problem assets.

PS. This is one of the many observations regulators have steadfastly refuse to comment on. If anyone of you is able to extract something of an answer from these not accountable to anyone regulators, I would be grateful to know about it.

The fatidic black-swan explanation still keeps us in the crisis

When you restructure a company that has gotten itself into financial problems, you do not inject new funds before you have made the structural changes that allow you to reasonably expect that the company will recover, and so that you are not just throwing good money after bad. 

Unfortunately there has been no fundamental or significant restructuring carried out at all during the current crisis. And that is because so many bought into the fallacy of this crisis being caused by a “black swan” event, one which no one could foresee, and which therefore needed not to happen again. Bank regulators have of course been especially fond of this concept, as it reinforces their innocence.

But no! This was no black swan event. When regulators allowed the banks to hold immensely less capital for exposures considered as not risky, “The Infallible”, than for exposure considered “The Risky”, they virtually doomed the banks to originate dangerously excessive exposures to “The Infallible”, precisely the kind of exposures that have always detonated major crisis when, ex-post, these appear as very risky…. like triple-A rated securities backed with lousily awarded mortgages to the subprime sector, like Greece, like Spanish real estate… 

And so all bail outs, fiscal stimulus and quantitative easing done, without any fundamental structural change, like eliminating the capital requirements for banks which discriminate based on perceived risks, have just wasted preciously scarce fiscal and monetary policy space. 

When are our governments to wake up to the fact that those who messed it up were the not so white white-regulator-swans? And to the fact that the Basel regulatory paradigm is silly and sissy and must be thrown out the window... urgently?