Saturday, February 27, 2010

Absurd and naïve bank regulations stand in our way!

The European Commission initiated on February 26, 2010 additional public consultations on changes to the Capital Requirements Directive for banks (CRD). The following was my response.

Sir,

The world swallowed the idea proposed by the bank regulators that if one creates incentives for banks to finance what is perceived as having less risk, and disincentives to avoid what is perceived as having more risk, then we would all be better off.

The regulators implemented it by placing lower capital requirements on those bank operations that are perceived by the credit rating agencies to have lower risk of default, the AAAs, than on those perceived as having higher risk, the BBBs of the world.

What an absurd and naïve thing to do!

• As if there was enough real AAAs to go around!

• As if economic growth and human development resided primarily in AAA land!

• As if you need to give more incentives to the AAAs already favored by the natural cowardice of capitals!

• As if you can measure risks without risking affecting those same risks.

• As if those operations perceived as less risky did not face the risk of more carelessness.

• As if those human fallible credit rating agencies would not be subject to very strong pressures to award the AAAs.

What happened? What was doomed to happen!

Increasing the value of the perceived safe-havens created incentives for selling some not so safe havens as safe, by influencing perceptions, which led to dangerously overcrowding a subprime haven; which caused the current financial crisis.

What needs to be done? Start from scratch!

There is no way to build something good on top of a foundation as faulty as the Basel Committee´s “The First Pillar – Minimum Capital Requirements”. Unfortunately this could prove to be an impossible task if keeping those regulators who so entirely succumbed to the current paradigms.

Europe, wake up! The current crisis did not result from excessive risk-taking. It was the result of misguided excessive risk-aversion. The losses occurred in AAA land not in BBB land.

Europe, wake up! Risk-taking is what takes one forward. Risk aversion can only guarantee being diminished. Europe, do not allow yourself to be diminished! Rest of the world that goes for you too!

Per Kurowski