Harvard Law School. I hope you did not believe Bill Coen with that the Basel Committee knows what it’s doing.

Bill Coen, the Secretary General of the Basel Committee on Banking Supervision, spoke at the Harvard Law School on December 12, 2016. In: “The global financial crisis and the future of international standard setting: lessons from the Basel Committee” Coen had this to say about the metric of the risk-weighted ratio:

“Its strength is that it sets capital requirements according to the perceived riskiness of a bank’s assets.” 

Comment: It is sheer lunacy to set capital requirements according to ex ante perceived risks, when you should set them according to the risk that banks might not adequately perceive the riskiness of their assets. In fact all bank crises have occurred from unforeseen events (like devaluations), criminal behaviors or excessive exposures to what ex ante was perceived as safe but that ex post turned out to be risky. No bank crisis has ever resulted from excessive bank exposures to something ex ante believed risky.

“Its weakness is that it is susceptible to setting too low capital requirements, either unintentionally (model risk), or intentionally (gaming).”

Comment: This evidences mindboggling naiveté. For banks to earn the highest possible risk adjusted returns on equity, they will automatically look to hold as little equity as possible. So it is like placing some delicious cookies in front of children, and expecting them to reach out for the spinach.

Students and professors at Harvard Law School, do us all a big favor. Send Bill Coen the following questions, and ask him formally to respond. At least that would save me from having to go on a hunger strike or other similar extremes in order to get some answers.

PS. You could also ask the Harvard Business School about why they have kept such silence on the monumental mistakes of current bank regulations.

What "market triumphalism" are you referring to Professor Michael Sandel?

Michael Sandel, in “The Art of Theory Interview” refers to: 

“a tendency, over the past three decades, of economics to crowd out politics. This has been an age of market triumphalism. We’ve come to the assumption that markets are the primary instruments for achieving the public good.”

And that is a much distorted, and quite often a very interested version of what is actually happening.

Over the last few decade banks, instead of allocating their credit based on adjusting to the perceptions of credit risk, by means of the interest rates (risk premiums), and the size of their exposures, have also had to adjust those credits to capital requirements (meaning equity requirements), and that are also based on the same ex ante perceived credit risks.

“More risk more equity – less risk much less equity” has translated into banks earning much higher risk adjusted returns on equity when lending to “the infallible” than when lending to “the risky”. 

For instance, a bank, according to Basel II, when lending to an infallible sovereign, can hold zero equity but, when lending to a citizen, it has to have 8 percent of equity.

That means banks can leverage their equity 12.5 times to 1 lending to citizens while not even the sky is the limit when lending to their sovereign. 

Professor Sandel, what on earth has that do with "market triumphalism"? It has all to do with an obnoxious non-transparent triumph of government powers.

And the credit risk aversion introduced by bank regulators, effectively blocks "the risky" from having fair access to bank credit, and thereby impedes equal opportunities and promotes inequality.

Is this all a conspiracy of some mighty self declared "infallible", against us their declared "risky" citizens?

It looks like we honest citizens again need to take refuge in a Sherwood Forest, in this case among the trees making a living in the world of shadow-banking. Hell, they are now even trying to convert our Robin Hood into a Sherif of Nottingham tax-collector for King George.

Dear finance professors of the world, can you please help me?

Before the Basel Committee regulations’ era, banks cleared for (ex-ante) perceived risk, that information which for instance is to be found in credit ratings, by means of interest rate (risk-premiums), the size of the exposure, and other contractual terms; let us call that “in the numerator”. 

But Basel II, and now Basel III, instruct the banks to also clear, I would call it re-clear, for exactly the same (ex-ante risk) perceived risk, credit ratings, “in the denominator”, by means of different capital requirements, more risk more capital, less risk less capital. 

That is just plain crazy. Allowing banks to leverage many times more when lending to what is perceived as “safe” than when lending to what is perceived as “risky”, allows the banks a much higher expected risk-adjusted return on equity when lending to “The Infallible” than when lending to “The Risky”. That distorts and makes it impossible for banks to allocate resources efficiently.

Recently Anat Admati and Martin Hellwig published an excellent “The Bankers’ New Clothes” 2013, though I think “The Regulators’ New Clothes” would have been a better title. But, in one passage they write “Whatever merits of stating equity requirements relative to risk-weighted assets may be in theory, in practice…” 

And, dear finance professors, my problem is that I have not been able to find anything yet that I would include within the “Whatever merits”. 

Besides the so fuzzy “more risk more capital, less risk less capital, it sounds logical”, do you have any idea why the regulators did that? If not, can you help me asking around? 

I mean, it is no minor thing that our whole banking system seems to be driven by a loony double consideration of perceived risks.

I mean it is no minor thing that our bank regulators have decided to favor “The Infallible” those already favored by the market and bankers and thereby discriminate against “The Risky”, like all our small businesses and entrepreneurs.