How Capital Regulation Creates Systemic Risk
By Arnold Kling
any set of regulations that attempts to assign risk to all securities in the same way for all banks would necessarily create some regulatorily-favored group of securities because the objective algorithm assigned too low an amount of risk capital to those securities purely as a result of statistical flukes and selection bias. Were each bank to do the analysis itself, their errors would be more r andom and less likely. Unfortunately, with a comprehensive system of regulations, identical errors pervade all banks.