Basel‘s Monstrous Regulatory Mistake

Posted by Per Kurowski on 20 April 2011

The Basel Committee made a monstrous regulatory mistake in Basel II, when they considered the credit ratings of the clients of the banks when setting the capital requirements for banks, even though the information provided by the credit ratings was already being considered by the market and the banks when setting their risk-premiums and interest rates.

Even if the credit ratings had been perfect it would have been wrong as something considered excessively, can be much worse than something not considered at all. But, of course, being the credit ratings the product of human fallible raters, so much the worse to leverage the importance of their failings.
That stupid and unforgivable mistake resulted in:
1. The setting of minimalistic capital requirements that served as growth hormones for the ‘too-big-to-fail’.
2. That banks overcrowded and drowned themselves in shallow waters, whether of triple-A rated securities backed with lousily awarded mortgages to the subprime sector, or of equally or slightly less well rated “rich” sovereigns, like Greece.
3. A serious shrinkage of all bank lending to small businesses and entrepreneurs as lending to these generated, in relative terms, much higher capital requirement, which made it difficult for them to deliver a competitive return on bank equity.
With Basel III, regulators, instead of correcting the mistake, are trying to correct for this mistake, which can only result in a serious case of overmedication and in the Basel Committee digging us deeper in the complex hole where they placed us.