Saturday, April 30, 2022

The current risk weighted bank capital requirements: A Maginot Line

My Twitter thread:

What if generals concentrate too much on the immediate risk sergeants perceive?
I ask because regulators now concentrate too much of their bank capital requirements on the risk perceived by credit rating agencies and bankers.
The result? A false sense of security. A Maginot Line.

Any risk, even if perfectly perceived, if excessively considered, causes the wrong action.
With bankers adjusting for risk with interest rates, and regulators with bank capital requirements, there will be dangerously much “safety” and dangerously little risk-taking.

Too much safety? 
The excessive bank exposures and the assets bubbles that can become dangerous for bank systems and the economy, are always built-up with assets perceived (or decreed) as safe, never ever with assets perceived as risky.

Too little risk taking? 
Risk taking is the oxygen of any development
If e.g., residential mortgages are favored much more than bank loans to small businesses and entrepreneurs, we will end up with too expensive houses and too little job income for food, utilities… and mortgages

What if the generals took much more care of the needs of their headquarters, than those of the soldiers in the battlefield?
I ask because the regulators who, for bank capital requirements, have decreed risk-weights of 0% the government and 100% the citizens, are doing just that.

What if armies don’t arm during peace?
I ask because when times are good, is when banks should buildup capital
The risk weighted bank capital requirements, do the opposite
So, when times turn bad, our banks will stand there naked, just when we need them the most
Good Job! ūüė°

Regulators, the Basel Committee for Banking Supervision, imposed bank capital requirements based mostly on perceived risks, not on misperceived risks or on unexpected events e.g., a pandemic or a war. 
Oh, if only they had taken time off to play some war games before doing so.