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Causal Capital ~ The Knowledge Capital Specialists

BIS Post Crisis Treatments

The Bank for International Settlements has just released a Post Global Financial Crisis treatment update and in its eyes all is good with the world, things are supposedly on track. I am not sure I entirely agree with the findings or the plans going forwards and I have my reservations but let's take a look nonetheless.

The report can be found here | BIS Finalising Post Crisis

On the surface, risk management or at least the coverage of it as Basel III has it defined has been completed at a regulatory level. However, if one was to test some of the banks on the ground and see where they are at with these enhancements, you are likely to find a very different story from what is depicted in this document.

Then there is the "complimentary reforms" paragraph such as review and correction of systemic flaws in the shadow banking sector. These are not minor pieces of work that compliment a Basel III risk framework but perhaps the elephant in the room to why the global financial crisis dealt such a hard blow to banks from the outset.

Finally there are these predilections:

SIMPLICITY | "Challenged the ability of a bank’s board to understand and oversee the way in which the bank manages its risks"

What BIS is saying here is that a typical board in a bank isn't up for the complex task of understanding risk management so we need to simplify the measures!

A better idea would be to stipulate minimum knowledge requirements for board members of banks. Don't dumb down the system, lift up the standard.

The idea that risk can be simplified is a misdemeanour anyway, let me elaborate:

Risk can be seen as being made up of two forms at the end of the day; randomness and epistemic uncertainty or our lack of knowledge of how something works. Simplifying the epistemic aspect of a risk measurement often forces risk deeper into the realm of randomness, it doesn't go away but it does transform into an opaque form that reduces what we know about it.

COMPARABILITY | "A number of studies have found material variation in risk-weighted assets across banks"

This is entirely possible of course as banks sell products with different contractual variations, it's called competitive business practices but these differences are not the hazard BIS seems to claim they are. If anything, it shows diversity in the banking sector and that will translate to systemic resilience at the end of the day.

Being comparable should not be seen as being homogenous, there is little to compare when things become more alike.

SENSITIVITY | "A number of empirical studies have suggested that simpler metrics are at times more robust than complex ones. This suggests that the blanket use of internally modelled approaches may not always measure and differentiate risk accurately"

This statement is an oxymoron, it really is. Blanket use or standardisation of internal models is simpler than bespoke risk modelling, I doubt that very much.

Going forwards, BIS have identified three reforms that need attention:

(i) Enhancing the risk sensitivity and robustness of standardised approaches

(II) Reviewing the role of internal models

(III) Finalising the design and calibration of leverage ratios

Surely we are better off assisting banks away from standardised approaches and into the Internal Ratings Based end of the game. If BIS just focused on doing nothing else but this, many of the other problems it is concerned about as a global regulator would be negated.

There are plenty of other issues hidden in this report but if BIS believe keep it simple will translate to less risk being taken by banks, they have a horrible shock awaiting for them around the corner.

Risk systems don't need simplification; risk reporting needs completeness, harmonisation and integration within each institution. If anything, front to back risk systems are likely to become more complex if they are to become more complete.

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