Again, the two basic questions the bank regulatory establishment does not dare, want or know how to answer.

If banks already look at the credit information provided by credit ratings when setting interest rates, amount to lend and other terms, do you think it is intelligent for the regulators to also look at the same credit ratings, or similar risk perceptions, in order to define the capital requirements for banks? Is that not overdoing the nanny part a bit too much? Could that not lead to a dangerous overexposure to whatever is officially deemed as absolutely not risky? Like to triple-A rated securities and infallible sovereigns? 

And is not the whole idea of lower capital requirement for banks when the perceived risks are low just a dumb idea from the very start, knowing, as we do, that big systemic bank crises never ever occur because of excessive exposures to what is believed to be risky, but that they always occur because of excessive exposures to what was wrongfully believed as absolutely not-risky?

About cruise ships and banking regulations

Put it this way. If you go on a cruise would you want it to be insured against all risks or not? As I see it if it is completely insured, chances are that the captain could be a social relations captain, and if it is completely uninsured, the chances are much larger that the captain is a real marine captain. Your pick! 

When the regulators allowed the banks those ridiculous capital requirements of 1.6 percent or less, just to navigate those waters perceived as absolutely not-risky, precisely the waters where in fact all the major bank crisis have occurred, they basically provided the banks with a total insurance… causing social-relation and trading bankers to substitute for real bankers.

Financial repression

Financial repression, a term coined in 1973 by Stanford economists Edward S. Shaw and Ronald I. McKinnon, is used to describe several measures that governments employ to channel funds to themselves and which in a deregulated market, would go elsewhere. In other words it is a hidden non-transparent tax. 

How much financial repression is present by the fact that the banks need to hold immensely much less capital when lending to its “infallible” government than when lending to the “risky” citizens? We have no idea… as we are flying blind with instruments that long ago ceased to function.

Bank regulators should learn about risk compensation and shared space philosophy.

Risk compensation, nothing to do with bonuses, is an effect whereby individual people may tend to adjust their behavior in response to perceived changes in risk. Individuals will behave less cautiously in situations where they feel "safer" or more protected. It is an argument that might help to explain the apparent paradox that reduced regulation leads to safer roads. 

The perceived risk of default in finance, functions like a natural traffic light. If the perceived risk for default of a borrower is high, the light yellow or red, banks lend less, at higher interest rates and on tougher terms. If the perceived risk for default of a borrower is low, the light green, banks lend more, at lower interest rates and on more lenient terms. 

The regulators though, with their capital requirements for banks based on perceived risks, by allowing for extraordinarily low capital requirements when the perceived risk were low, working like a collider, induced the banks to drive through the green lights much faster and with much lesser care, which resulted of course in this the mother of all financial pile-ups 

After a bank crisis characterized, as usual, by monstrously large exposures to what was officially considered as absolutely safe, like triple-A securities and infallible sovereigns, risk compensation is something our bank regulators should look into much more closely. 

According to the Shared-Space urban design philosophy, safety, congestion, economic vitality and other similar issues can be effectively tackled in streets and other public spaces by allowing traffic to be fully integrated with other human activity, not separated from it. Shared-Space streets have no traditional road markings, signs or traffic signals, and the distinction between "road" and "pavement" is blurred. The behavior of its users is more influenced and controlled by natural human interactions than by artificial regulation. 

Hans Monderman, 1945-2008, the Dutch traffic engineer known for his prominent role in the Shared-Space approach, was quoted saying: "We're losing our capacity for socially responsible behavior... The greater the number of prescriptions, the more people's sense of personal responsibility dwindles... When you don't exactly know who has right of way, you tend to seek eye contact with other road users... You automatically reduce your speed, you have contact with other people and you take greater care."

These days, when with their Basel III the regulators are digging our banks even deeper in the hole of excessive perceived safety, and we want and need our bankers to be better bankers and better citizens, we sure wish the Basel Committee would at least listen to some Shared-Space specialists.

PS. Risk-weighted capital requirements for banks, is also like allowing cars to go at different speeds depending on safety features, rated by "experts" and, of course, driven by fallible humans!!!

Let us thank our lucky star the credit rating agencies were not that good

Bank regulators gave tremendous importance to credit ratings, especially in the Basel II package approved in June 2004. 

One of the problems with that is that if a credit rating has already been issued, and if it is good one, like an AAA, there is absolutely no incentive for a second opinion, as no one is going to pay the price of a second opinion that might differ from the first opinion, only once in awhile. And this is especially true if the First and Official Opinionater, has had access to privileged information about the borrower, as they very often have. 

Though we are indeed already suffering seriously the consequences of some of the credit ratings being wrong… can you imagine where we would be if they had delayed making their mistakes ten more years, and the banks and regulators had had the time to invest so much more trust in them? Can you imagine the altitude from which we would have fallen? 

Indeed there is someone looking after us! So at least let us be grateful for that and make amends! 

PS. What on earth do you think I was referring to, when in January 2003, in a letter to the Financial Times I wrote, “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds”?