Bank of England's Robert Jenkins: "Regulators dumb to trust banks"

As reported by the Telegraph, the Bank of England's Financial Policy Committee member Robert Jenkins observed

regulators had been “dumb” to trust banks’ ability to manage risk-taking in the run up to the financial crisis. 

"The regulatory establishment blew it. First we misjudged the breadth and depth of the risks that many banks were running. Second, we misjudged bankers' ability to judge and manage those risks,” he said. 

Speaking at a dinner in the City of London, he added: “How could we have been so dumb as to believe that bankers were so smart? Both groups belong to the human race and the human race is hubris hungry and error prone." 

Actually, regulators have been "dumb" to trust bankers at all.

As the Libor scandal has shown, bankers are perfectly willing to lie to enhance their income or to try to boost their image of financial stability.

He proposed a solution whereby banks increase the minimum level of capital they hold and in return are granted a "moratorium on all new regulation" as well as a review of existing rules. But he stressed that it was not within his power to implement the idea and that he offered it only in a "private capacity". 

"In short, higher capital requirements are compatible with economic growth and are compatible with shareholder value - they just are not compatible with non-risk adjusted banker pay," he said. "Is banking regulation too tough? No. Is the demand for higher capital damaging? No."

While I like the idea of a simple tradeoff like Mr. Jenkins proposes, higher capital requirements should not be part of the tradeoff.

Regular readers know that higher capital requirements would not have prevented the financial crisis that began in 2007, they would not have prevented JP Morgan's credit default swap trades and they would not have prevented the Libor scandal.

Regular readers know that the demand for higher capital in the absence of the requirement to recognize all the losses on and off the banks' balance sheets is damaging.  The financial regulators' quest for higher capital requirements since the financial crisis has precipitated a credit crunch and made it virtually impossible for creditworthy borrowers to get loans.

What is even worse, it is not clear that higher capital requirements would have prevented the policymakers and financial regulators from adopting the Japanese model for handling a bank solvency led financial crisis.  Under this policy, society is sacrificed to maintain book bank capital levels.

Mr. Jenkins' simple tradeoff would work better if it went as follows:

banks provide ultra transparency under which they disclose on an on-going basis their current asset, liability and off-balance sheet exposure details and in return are granted a moratorium on all new regulations (including liquidity and capital) as well as a review of existing rules.