Wednesday, January 19, 2011

The principle of bank regulations that has been and is so rudely violated

Regulators should accept that bankers believe they can master quite adequately the risks of default. Who would want to deal with a banker who does not believe so?

But in the same vein the regulators should always tell the bankers “No you can’t… and besides there are so many other risks to be considered than just avoiding the defaults of your clients and the defaults of yourselves”.

And foremost regulators should never ever themselves become risk-managers… a principle that was and is so rudely violated.

It is bad enough when regulators fall for the sales pitch of bankers and believe too much in their risk-management ability, but so much worse when the regulators arrogantly believe, as they currently do, that they know themselves what the risks are and that they know themselves how to properly manage and master these… with or without a little help from the credit rating agencies.

A credit rating sends out on its own a very positive or negative signal to the market. When regulators based the capital requirements of banks on those same credit ratings, they dramatically augmented the strength of those signals… to such an extent that banks went and drowned themselves in triple-A rated waters wearing no capital at all… to such an extent that lending to the “risky” small businesses and entrepreneurs has come to a halt because that requires too much capital, especially when bank capital is very scarce as a result of having invested or lent too much to the ex-ante “not risky”.

Currently the regulators, who like risk-managers already failed in conquering some simple risks of defaults, when foolishly playing around with their capital requirements based on perceived risks, and ignoring that systemic crisis never ever results from timely perceived risks, are now tackling more God-like events like pro-cyclicality. God help us!