#SA

In the wake of the 1,089-page capital proposal, debate is waging on well-trod battlegrounds such as whether the new approach will dry up credit and thus stifle growth.  I’ve my own view on this, but my initial read of the proposal points to a still more fundamental issue:  some of it makes absolutely no sense even if one agrees with the agencies’ goals.  Here, I lay out two bedrock assumptions that contradict the rule’s express intent and will have adverse unintended consequences to boot.  God knows what lurks in the details.

The first “say what” in the sweeping rules results from the new “higher-of” construct.  Credit and operational -risk models are entirely gone and market-risk models are largely eviscerated.  Instead, big banks must hold the higher of the old, “general” standardized approach (SA) or the new, “expanded” SA.  Each of these requirements is set by the agencies – models mostly never allowed.  Further, a new “output floor” – different from Basel’s approach to this model’s constraint – is also mandated as yet another safety net preventing anyone gaining any advantage from any possible regulatory-capital arbitrage.

Why then not just demand that big banks use a standardized weighting the agencies think suffices?  Must banks be put through the burden of calculating two ratios when they have no ability to arbitrage requisite capital weights?  Do the agencies not even trust themselves to set capital standards that are now sometimes higher, sometimes lower as God gives them to know probability of default …