I think the coronavirus crisis ought to have really undermined this kind of modelling. As we've seen, the bad thing about widespread bankruptcy isn't that banks might have enough capital - it's that everyone's bankrupt! voxeu.org/article/how-mu…
In a situation like the COVID shock, it's obviously appropriate for the government to try to ease the constraints and insulate the nonfinancial corporate sector. The government has to provide that sort of insurance - or at least it's massively more efficient for it to do so ...
(if you want bank sector capital to be the cushion that protects against shocks of that size, then a) you need to rewrite the bankruptcy code, b) 24 years out of 25, solvent borrowers are going to be paying a premium for this risk and c) cmon, b) isn't a credible equilibrium
Bank capital requirements fundamentally aren't there to absorb massive exogenous losses like those caused by pandemics or wars. They are for the most part there to try to mitigate *endogenously caused* business cycles, where banks lend too much.
That means that, beyond a certain level probably somewhere between the Basel 1 and 2 requirements, bank capital is simply a measure of the extent to which supervisors would really like to put lending restrictions in place but don't have the mojo to do so.
... which implies there's no tradeoff and therefore no optimum. the toy model in which capital is a buffer against random shocks drawn from a probability distribution doesn't describe how the industry works. To conclude with a proverb -
Banks don't fail because of high risk business. Everyone knows high risk business is high risk and takes care. Banks fail because of low risk business which ain't.
Envoi - this is a huge problem for @EBA_News this year, because they have to prepare a stress test which fulfills the dual goals of a) being a credible worst case pandemic scenario and b) being a useful basis on which to set capital requirements out to 2023. Good luck ...

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More from @dsquareddigest

25 Nov 20
to expand on this. What I dislike is not so much the mechanics of how QE works - which, to be frank, the man in the street is correct not to care about, and where experts are hardly in consensus - as the lack of the concept of "a policy variable". By which I mean ...
... if the UK was borrowing short term in USD (or indeed, when Greece was doing so in EUR), it would indeed be at very great risk of sudden movements in short term interest rates. But the UK, in GBP, is borrowing in a currency where the interest rate is a policy variable.
Peston's article reads as if he's saying that Mervyn King set a booby-trap - that because of QE, there's a danger that we won't be able to finance the COVID stimulus. The seeming mechanism is - COVID reduces capacity - output rises - inflation - higher funding cost - AAARGH! ...
Read 9 tweets
25 Nov 20
If you read through this asking yourself the question "how many of the horrible errors people made over Labour antisemitism are being reproduced in this article?" it's really striking.
That's not really a knock on Wilby (still less a defence of any of the other figures to have gone "this is all exaggerated and think about the free speech issues"). Just interesting that it's often quite difficult, when you're not on the receiving end, to recognise that ...
... that something is actually bigotry, not just "views you disagree with". To a large extent it depends on leaders in the affected community having someone in the mainstream media who will answer their calls, which is why, I think people are so shocked that ...
Read 5 tweets
5 Jun 20
Kind of a worrying feeling that at present I am on track to make more money out of The Share Prices this month than all of my businesses put together. Very tentative thread...
... I think the @EpsilonTheory bloke is right to compare this to the Bear Stearns bounce. But history rhymes, it doesn't repeat itself. Sometimes it doesn't even rhyme, it just shares consonant sounds like traditional Welsh verse ...
... in this case, the cynghanedd is the theme of "massive policy mistakes". We had the Bear Bounce because the market presumed that systemic risk was being correctly underwritten, followed by the Lehman plunge when it wasn't. This time ...
Read 7 tweets
21 Apr 20
OK I disagree with this pretty fundamentally. It's not a "pass" or "going easy". Here's a THRED on backtesting exceptions ....
The "backtesting exception" is a euphemism for "the VaR model didn't work", as they often don't. You have to record one every time you get (broadly) a movement in the "hypothetical P&L" on any given day which is greater than the 99% 1-day VaR. Whoa hang on ...
"hypothetical P&L" basically means, oversimplifying wildly, "the movement in the daily valuation of the trading book". It differs from "actual P&L" because you're always *trading* that book, so your actual prices achieved might be different from the daily valuations....
Read 15 tweets
13 Apr 20
I can do you a quick inquiry if you like, from general knowledge and generic reasoning ... (1/4)
*Who leaked it*?

One of the dozens of people who had a copy and was angry that it was about to be swept under the rug.
*Is all the stuff about shockingly poor practices in the compliance unit true*?

Of course it is, how do you think you get such bad results?
Read 9 tweets
19 Mar 20
A point I think I should have 'splained earlier; coronavirus isn't normal economic recession. In this case we *want* much lower consumption for a short period. We want to make sure we can bring it back in as intact a state as possible when we want consumption back.
That means the normal policy - concentrate your support on people with lower incomes because they have higher marginal propensity to consume - isn't right for this situation.
What we want to preserve is *employment*, because there is huge deadweight loss when a worker is fired or a company is wound up. Usually in a Keynesian recession you do that by demand management. But we don't want demand to go up - we want people to stay at home!
Read 6 tweets

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