I found some qualified support for one of my ignored arguments against current credit risk weighted capital requirements for banks.

In Charles Goodhart’s “The Basel Committee on Banking Supervision: A History of the early years 1974-1997" I just discovered, tucked away in a small note right before the Epilogue and with no reference in the index, the following about “unexpected losses”

“In so far as capital is required against unexpected loss, since expected loss should be handled by appropriate rate margins, the use of credit ratings as a guide to risk weights for Capital Adequacy Requirement’s is wrong and inconsistent, since these give a measure of expected credit loss… If capital requirements had been based, as they logically should have been, on the uncertainty attending future losses, rather than their expected modal performance, the financial system might have avoided much of the worst disasters of the 2007/2008 financial crisis”

That is what I have argued of years. Does the fact that somebody knew it, and said it, and yet it was ignored not clearly reflect that something smells very rotten in the Basel Committee for Banking Supervision?

How on earth do we allow our banking system to be in the hands of such irresponsible regulatory charlatans? Have they not done enough damage as is?

And of course, this is but one of many regulatory mistakes/sins they have committed 

PS. On the specific issue of expected risks substituting for unexpected risks, I have written around 50 letters to the Financial Times, but they have all been ignored. Perhaps when now raised by one with much better standing than me, it will at long last be brought into the debate.

PS. For instance in 2001 the Fed, FDIC and OCC set the following risk weight depending on credit rating; AAA to AA 20 percent; A 50%; BBB (the lowest investment grade) 100 percent; and BB (below investment grade) 200%. If that’s not runaway nonsense what is?