Should risk weighted bank capital requirements be based on perceived risks, or conditioned-on the risks perceived?

The Basel Committee, and co-regulators all base it on perceived risks. Mark Twain would have gone for the conditioned-on risks perceived. Why? “A banker is a fellow who wants to lend you the umbrella when the sun shines and wants it back when it rains”. (Supposedly)

Twain understood that bankers, conditioned upon them perceiving risks as low, will gladly hand out loads of loans which, when conditioned on them perceiving the risks as high, they would want to collect, as fast as they could.

Sadly, all current bank regulators clearly missed their lectures on conditional probabilities, and therein lies the problem.

Now, when credit risks are perceived as low, their risk weighted bank capital requirements allow banks to lend profusely against little capital, meaning being able to pay high bonuses and dividends and do plenty of stock-buy-backs. When risks are or become perceived as high, e.g., in a recession, then banks must hold more capital, just when it is the hardest for them to raise it, just when we probably need banks the most.

To understand the point, an on the scene live reportage the morning after a bank crisis interviewing all those Monday Morning Quarterbacks that beg to be interviewed all mornings after, would satiate us with the mention of some huge specific loads of very risky assets. And those suffering the availability heuristic a.k.a. the availability bias, would nod their heads in agreement. 

From Wikipedia we read: “The availability heuristic operates on the notion that if something can be recalled, it must be important, or at least more important than alternative solutions which are not as readily recalled. Subsequently, under the availability heuristic, people tend to heavily weigh their judgments toward more recent information, making new opinions biased toward that latest news.”

But, if a documentary was produced on what years/moths lead up to that crisis, it would certainly retell how those huge dangerous bank exposures were built up with assets deemed very safe. That documentary would seriously contradict the live reportage and the Basel Committee, and strongly agree with Mark Twain.

The problem with data is that when they are taken/registered also matters a lot.

Sadly, the safety of our bank systems is not only what’s endangered. Also the health of our economies. These risk averse bank capital requirements cause too large exposures to what’s “safe”, e.g., government debt and residential mortgages, think of it as demand pushing carbs; and too small exposures to what’s “risky” e.g., loans to small businesses and entrepreneurs, think of these as supply producing proteins. The result? Dangerous economic obesity.