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Letter to the Editor

Finance & Development  

A caution on credit ratings

March 5, 2012

Panayotis Gavras´s “Ratings Game” covers many interesting aspects, except for, unfortunately, what really constituted the fundamental mistake of Basel regulators when using the credit ratings when determining capital requirements for banks.

Banks already clear for perceived risks, like those included in credit ratings, by means of the interest rates, the amounts exposed and the other general terms. And so, when regulators set the capital requirements also based on the same perceptions, they are double dipping into perceptions, causing what is officially deemed as not risky to become even more attractive and what is officially deemed as risky to become even less attractive.

Any information, like risk of default information becomes bad, even if it is perfect, if excessively considered.

The reason this has not been understood can perhaps be explained by the fact that almost everyone speaks about this crisis as a result of excessive risk-taking… even though the fact that all the problems are derived from excessive exposure to what was perceived as absolutely not risky; and that there is a lack of exposure to the officially “risky”, like to small businesses and entrepreneurs, would indicate us being more in the presence of a regulatory induced and perverse excessive risk-adverseness.

Regulators, when they with hubris decided to play the risk-managers for the world, just forgot or ignored the fact that all bank crises have always resulted from excessive exposures to what was considered as safe, and never ever form excessive exposures to what ex-ante was considered to be risky.

Regards

Per Kurowski

A former Executive Director at the World Bank (2002-2004)

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