Bank regulators have placed the consequences of volatility on steroids

I refer to Robert Burgess’ “Volatility Is the Price of a Safer Banking System”

October 2004, at the World Bank, as an Executive Director, I stated: “Much of the world’s financial markets are currently being dangerously overstretched through an exaggerated reliance on intrinsically weak financial models based on very short series of statistical evidence and very doubtful volatility assumptions.”

Most of current bank capital requirements, whether Basel I, II or III are based on perceived credit risks. That means banks can leverage their capital/equity/skin-in-the-game the most with what’s perceived as safe. That means banks can build up those huge exposures to “safe assets” which can become extremely dangerous to bank system if volatility kicks in, and turn these supposed safe into very risky assets.

April 2003, at the World Bank I had also opined: "Nowadays, when information is just too voluminous and fast to handle, market or authorities have decided to delegate the evaluation of it into the hands of much fewer players such as the credit rating agencies. This will, almost by definition, introduce systemic risks in the market"

The 2008 crisis was caused by assets rated AAA to AA, which after Basel II banks were allowed to leverage with a mind-boggling 62.5 times, suddenly were discovered as very risky assets… you want having increased the impact of volatility any higher?

May 2003, at a workshop for regulators, I argued: “A regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation”. That translates into that the regulator should not try to hinder volatility, but learn to live with it. 

So, if we want a safer bank system, we must first get rid of the risk weighted bank capital requirements which have placed the consequences of volatility on steroids.