The world at large would have been better off without any Basel regulations

Posted by Per Kurowski on 8 February 2009

I refer to the Geneva Reports on the World Economy 11 titled The Fundamental Principles of Financial Regulation.

It is a good document, though, unfortunately, far from being good enough.

It is good because it recommends for instance “to exclude Credit Rating Organizations from the regulatory network altogether” and regards “both the Basel II approach to the use of credit ratings and the European proposals for their enhanced regulation as misconceived”, and this is something that goes to the very core of the Basel-failure.

It is far from being good enough because it does not take a sufficiently long step back from the trees so as to be able to see the forest. For that to happen there is a fundamental need of recognizing that the world, without the existence of the Basel Committee regulations, would certainly have suffered other financial crisis, but never a crisis as destructive as the current one.

In other words, the world at` large would have been better off without the work of the Basel Committee.

The previous recognition is needed so as to be able to introduce in the discussions the fact that one of the most prolific sources of systemic risk in the area of regulations is the existence of a monolithic mind-frame among the decision makers; like that of bank regulators who only have the avoidance of bank failures on their agenda and minds.

The above is necessary in order to remind all those involved of such simple facts that a bank that does not fail could still be a totally useless bank and that a bank that fails could still have been a very useful bank. We need to measure more the whole boom-bust cycle and not look only at the crisis. We need to regulate our banks so as to make the banks are useful and, if they fail in the process that it has at least been worth it.

We therefore must stop our regulators from meddling with “risk” not only because risk is the oxygen of any development and we cannot afford having our regulators taxing risk, like they de-facto do with their current formula of capital requirements; but also because the riskiest risks that exists are those risks that many believe have been taken care of.

A regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, would be a much more effective regulation.

The avoidance of a crisis, by any means, sets us up in the direction of the one and only bank—the mother of all moral hazards—the mother of all bank crises.

Does this mean we should not regulate our banks? Of course not! But given that some of the authors of the document referred to also wrote “An Academic Response to Basel II”, in May 2001 which contains much relevant and quite similar proposals and criticism, but that was blithely ignored by the deaf Basel, they should be among the first to understand that we need at least some new, different and less deaf members in the quire.

How more profoundly mistaken must you be in the world of financial regulators before you are held accountable?

What we as an absolute minimum should expect now from the regulators is that they do not dig us further in the hole we’re in. We have seen some worrying signs with proposals of systemic risk ratings for banks. Anything beyond very simple and transparent aspects, such as the amount of liabilities officially insured by governments, should be prohibited terrain.

In Against the Gods Peter L. Bernstein (John Wiley & Sons, 1996) writes that the boundary between the modern times and the past is the mastery of risk, since for those who believe that everything was in God’s hands, risk management, probability, and statistics, must have seemed quite irrelevant. Today, when seeing where Basel’s self appointed masters-of-the-risks have taken us with their regulatory risk management, it should be very clear that we have left out God’s hand, and the market, much too much.