They argue that as banks re-evaluate the probabilities of default and loss over a business cycle, regulatory capital requirements will fall in booms, as risks are perceived to be low, and increase in recessions, when pessimism replaces optimism, aggravating the underlying real economic cyclical pattern. Better risk management, these critics seem to be saying, will make the world less stable.
Let me stipulate that a regulatory structure based on formal risk-management techniques will imply, to some degree, a cyclical pattern of minimum regulatory capital requirements, exactly like the internal pattern of economic capital needs at a bank using modern risk-management techniques on its own. The question is: Is that a bad or good thing?