Tuesday, January 5, 2016

Reporters, this question could evidence whether bank regulators know what they are doing.

The Basel Committee decided that in order to make banks safe, these need to hold more capital (equity) against assets perceived as safe from a credit risk point of view than against assets perceived as risky. 

For instance in Basel II a private sector asset rated AAA to AA carried a 20 percent risk weight while an asset rated below BB- had a 150 percent risk weight. That meant banks needed to hold 7.5 times more capital against a below BB- rated asset than against a AAA to AA rated asset.

Allowing banks to leverage their equity differently based on credit risks obviously distorts the allocation of bank credit to the real economy, something that by itself could also be very dangerous for the safety of banks.

And so, the only way those risk weighted capital requirements for banks could be justified, would be if they really made banks safer.

But ask any bank regulator, like Stefan Ingves, the current Chair of the Basel Committee the following:

Sir, would you be so kind so as to provide us with one example of a major bank crisis that has resulted from excessive bank exposures to assets that were perceived as risky when placed on the balance sheet of banks.

If they cannot answer, should that not be a sufficient indication that they might have no idea about what they are doing?

I mean I can think of many instances were bankers were lulled into a false sense of security by good credit ratings, but I cannot for my life imagine bankers building up excessive exposures to something rated below BB-. Can you?