Friday, October 18, 2013

The Basel Committee´s and the Financial Stability Board's loony concept of our risks with banks. God help us!

Basel II assigns a 150% risk weight to loans rated below BB- which, since the basic capital requirement in Basel II is 8 percent, means that a bank is required to hold 12 percent in capital (equity) against those loans… an authorized leverage of 8 to 1.

And Basel II assigns a risk weight of only 20% to loans rated AAA to AA which, with the same basic capital requirement of 8 percent, means that a bank is required to hold 1.6 percent in capital (equity) against those loans… an authorized leverage of 62.5 to 1.

Q: If you were a regulator, what would you think poses the greatest dangers for us with the banks, the possibility of their excessive exposure to something rated AAA to AA which turns out to be risky, or their “excessive” exposure to something rated BB- which turns out to be even more risky than that?

A: The first of course. There would be very few or no "excessive" exposures to anything rated below BB-. And, if so, the banks would have collected a lot of risk premiums too... which is also capital (equity).

You see, the Basel Committee’s risk weights measure the risks of the assets and the borrowers for the banks, but not the bank risks for us. You see, our and the bank regulators’ problems with banks, have absolutely nothing to do with banks and bankers getting it right, and absolutely all to do with banks and bankers, getting it wrong!

You understand it... but the members of the Basel Committee and the Financial Stability Board don't.

And that kind of unwise risk-weighting is still part of Basel III. In fact, more than five years after a crisis erupted, as a consequence of many assets perceived as safe turning very risky, and banks then having almost no capital against these assets, the basic principle of their faulty method of risk-weighting is not even discussed.

And much much less do the current regulators understand that capital requirements adjusted for "perceived" risk-weights, completely distorts the allocation of bank credit in the real economy.

And we have placed our banks in the hands of this kind of regulators. God help us!