Necessary Fictions? The Politics of Risk-Weighted Capital in the Basel III Era

• In Event: International Monetary and Financial Governance

Abstract

Financial risk models are a central technology in financial governance. A central regulatory practice in this respect is the assignment of capital charges to banks based on the risks associated with their portfolios of assets. The dominant approach of regulators in the US, UK, and EU, as embodied in the recommendations of the Basel Committee on Banking Supervision, has been to set ever more finely grained standards for the measurement of a proliferating menu of risks. This paper is interested in how these rules interpret, measure, and purport to manage risk and uncertainty in financial markets, asking more specifically: What role does risk modeling play in the politics of financial reform?

To answer this question, I examine public comments submitted as part of the federal rule-making process for incorporating the Basel III recommendations into U.S. law. I analyze these comments with the goal of identifying how risk is interpreted as an object of governance in these debates.

I find that the majority of the comments responding to the proposed changes to US banking regulation are focused on the impacts of these changes on the provision and cost of credit to small business, minority borrowers, and would-be homeowners. For the most part, these comments dispute the consequences of the proposed risk measure on banks’ capital charges and the potential impact of these costs on credit availability and lending practices. A similar set of comments focus on the change to the risk weight associated with tax equity investments, arguing that this will negatively impact bank lending to clean energy projects financed with climate tax credits.

While it might be tempting to dismiss these public comments about the impact of Basel III on bank lending as largely irrelevant to the politics of risk modeling, I argue that they can in fact be interpreted as revealing the thinness of the premise that ever-more finely grained risk measures are adequate to insulate the real economy from the excesses and volatility of the banking sector: If the concerned and engaged public is largely unconcerned with the appropriateness of particular risk-weights and capital charges to the goal of enhancing financial stability, perhaps it is because they perceive this debate to be largely fictional in nature: as increasingly untethered from the immediate goal of promoting financial stability or the more general goal of insulating the real economy from the vicissitudes of the a model of banking in which investment and commercial banking are inextricably intertwined.

Author

• Erin Lockwood, University of California, Irvine